The article takes an overview of the fiscal and monetary challenges posed by the second covid wave and suggest ensuring the availability of liquidity.

GDP projections need to be re-examined

•  According to NSO’s provisional estimates for 2020-21, the annual contraction in real GDP turned out to be 7.3 per cent.
• The erstwhile GDP growth projections for 2021-22 are being re-examined to take into account the adverse impact of the second wave of the pandemic.
• The RBI has revised down its 2021-22 real GDP growth forecast to 9.5 per cent.
• Some other recent estimates (ICRA) indicate the feasibility of a 9 per cent growth.
•  It is also important to consider nominal GDP growth for 2021-22 since that would be a critical determinant of fiscal prospects. 
• In the light of supply-side and cost-push pressures, the RBI has projected CPI inflation at 5.1 per cent.
• The nominal GDP growth may be projected at 13.4 per cent, that is, 1 percentage point lower than Centre’s budget assumption of 14.4 per cent.

Fiscal aggregates

• The Controller General of Accounts’ data indicate a gross tax revenues (GTR) of Rs 20.2 lakh crore and net tax revenue of Rs 14.2 lakh crore for 2020-21. 
• The likely growth in GTR for 2021-22 may be derived by applying a buoyancy of 0.9.
• This gives a tax revenue growth of 12 per cent, translating that to projected gross and net tax revenues for 2021-22 would mean Rs 22.7 lakh crore and Rs 15.8 lakh crore respectively. 
• This implies some additional net tax revenues to the Centre amounting to Rs 0.35 lakh crore as compared to the budgeted magnitudes.
• The main expected shortfall may still be in non-tax revenues and non-debt capital receipts.
• According to the CGA numbers, their 2020-21 levels are respectively Rs 2.1 lakh crore and Rs 0.57 lakh crore.
• Applying a growth rate of 15 per cent on these, a shortfall in 2021-22 to the tune of Rs 1.3 lakh crore may arise in non-tax revenues and non-debt capital receipts.

So, how much would be the Fiscal Deficit?

• The growth rates of non-tax revenues and and non-debt capital receipts average to a little lower than 15 per cent during the five years preceding 2020-21.
• In any case, the large budgeted growth of 304 per cent in non-debt capital receipts for 2021-22 seems quite unlikely because of the challenges posed by the second wave.
• Taking into account RBI’s recently announced dividend of Rs 0.99 lakh crore to the Centre, the main shortfall may be in non-debt capital receipts.
• Together, the overall shortfall in total non-debt receipts may be limited to about Rs 0.9 lakh crore, or 0.4 per cent of estimated nominal GDP.
• This indicates that a slippage, if any, in the budgeted fiscal deficit of 6.7 per cent of GDP, as revised in view of the recently released GDP data, could be a limited one.

Way forward: Prioritise three heads

• First, an increase in the provision for income support measures for the vulnerable rural and urban population.
• Second, in light of the recent decision, the budgeted expenditure on vaccination of Rs 0.35 lakh crore ought to be augmented, at the very least, doubled.
• Third, additional capital expenditure for select sectors, particularly healthcare, should also be provided for.
• Together these additional expenditures would amount to Rs 1.7 lakh crore, about 0.8 per cent of the estimated nominal GDP.
• Thus, we need to plan for a fiscal deficit of about 7.9 per cent of GDP.

Borrowing programme would need RBIs support

• The Centre has announced borrowings of Rs 1.6 lakh crore to meet the shortfall in the GST compensation cess.
• Given the higher fiscal deficit, it would need to add to its borrowing programme another Rs 2.6 lakh crore, taking the total borrowing, including GST compensation, to about Rs 16.3 lakh crore, from Rs 12.05 lakh crore now.
• Borrowing by states would be in addition to this.
• The net result will be an unprecedented borrowing programme by the Centre which may require RBI’s support.
• RBI is injecting liquidity into the system through various channels.
• Banks have sufficient liquidity to subscribe to new debt.
• This is indirect monetisation of debt.
• This is not new, but the scale is much higher.
• Direct monetisation is best avoided.
• The success of the borrowing programme of the Centre depends on the support provided by the RBI.
• The support need not be direct.
• It can be indirect as is currently happening. RBI is injecting liquidity into the system in a big way.
• Despite this, the money multiplier is low.
• This may be attributed to two reasons: Low credit expansion and larger leakage in the form of currency.
• The potential for money supply growth is large.
• The discussion in the monetary policy statement on inflation is focused entirely on supply availability and bottlenecks in the distribution of commodities.
• The output gap is certainly relevant.
• But equally relevant in an analysis of inflation is liquidity in the system, and its impact on output and prices with lags.
• The injection of liquidity has its limits.

Conclusion

With higher expenditure, financed through borrowings, the impact of liquidity expansion on inflation needs to be monitored.

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