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GS Paper: GS3-03.Government Budgeting

  • What Centre must do to meet the economic challenges

    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.

  • Prices, profits and the pandemic: What RBI could do

    The article discusses the challenges in managing the inflationary pressure while ensuring the low interest rates and sufficient liquidity in the covid battered economy.

    Growing inflationary pressure

    • As the second wave eases, producers could pass on more cost increases to consumers, pushing up inflation.
    • Inflationary pressures are on the rise, globally and domestically.
    • Real rates in India have moved into the negative terrain and some measures of inflation expectations have begun to rise gently.
    •  WPI inflation was subdued last year during the first wave of the pandemic due to falling global commodity prices.
    • This year is different, as inflationary pressures have surfaced in the WPI.
    • And within WPI inflation, input prices are rising much faster than WPI output prices.
    • Producers do not seem to be passing on much of the rise in raw material costs to output prices, perhaps worried that already uncertain demand could weaken further.
    • After states roll back local lockdowns, the demand for goods and services will gradually picks up, producers may feel more confident about passing on raw material cost increases to output prices, pushing core inflation higher, particularly in the second half of FY22.

    RBI’s role: Dealing with impossible trinity?

    • Last year, RBI was faced with conflicting objectives on inflation, bond yields and the rupee, also known as the impossible trinity.
    • It bought dollars to prevent the rupee from strengthening too much and purchased government bonds to keep bond yields from spiralling out of control.
    • But this created excess rupee liquidity in the banking system, which over time can stoke inflation and other financial imbalances.
    • These conflicting objectives are also likely to linger this year, and RBI will have to juggle them carefully.
    • As the year progresses, space could open up for RBI to gradually shift the focus to inflation control.
    • With the current account moving into deficit, the balance of payments surplus is likely to fall, so RBI may not have to purchase as many dollars as last year.
    • The will result in decrease in domestic liquidity and ultimately an important part of the normalization of monetary policy and inflation control.
    • RBI would still need to buy government bonds to support the administration’s borrowing programme.
    •  However, a large carry-over of cash balances could act as a buffer—they totalled ₹2.5 trillion at the end of FY21, almost double the recent average.
    • This could help fund some of the unbudgeted rise in the fiscal deficit.

    Way forward on controlling inflation

    • If the need to buy dollars is lower than last year, RBI could gradually shift the focus to controlling inflation.
    • Starting in 4Q 2021, when the proportion of the population vaccinated will hopefully reach critical mass, RBI need to start reducing the level of surplus liquidity, raise the reverse repo rate, and change its monetary stance to neutral.
    • The aim should be to gradually push up short-end rates towards 4%, so that real rates don’t remain hugely negative for too long.
    • An increase in the benchmark repo rate— currently 4%— can wait, perhaps until there are surer signs that the private investment cycle is rising.

    Conclusion

    Dealing with the three elements of impossible trinity this time is not as difficult for the RBI as it was last year, it needs to shift focus to inflation control at the opportune moment.

    Back2Basics: Real interest rate

    • A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor.
    • The real interest rate of an investment is calculated as the difference between the nominal interest rate and the inflation rate.

    Real Interest Rate = Nominal Interest Rate – Inflation (Expected or Actual)

    The impossible trinity

    • A theory that states that, in the long-run, a central bank that hopes to conduct independent monetary policy must choose between maintaining a fixed foreign exchange rate and allowing the free movement of capital.
    • For instance, a central bank that chooses to increase the total money supply by adopting loose monetary policy cannot hope to maintain the foreign exchange value of its currency unless it resorts to restricting the sale of domestic currency in the currency market.
    • The idea is derived from the academic works of Canadian economist Robert Mundell and British economist Marcus Fleming.

  • Don’t worry about the deficit

    The devastation caused by the second wave calls for the government to shed its worry over the fiscal deficit. The article deals with this issue.

    Role of fiscal policy to support economy through second wave

    • As India battles to contain the surge in COVID-19 cases, several states have already imposed severe restrictions at the local level.
    • The services sector has been hit the most as a consequence of these lockdowns and it would be difficult for India to deliver on this optimistic growth projection.
    • Against this background, the role fiscal policy can play to support the economy needs consideration.
    • The monetary policy is already accommodative and may not have enough room to further boost the economy.
    • With headline as well as core inflation inching up in recent months, the RBI may not be in a position to further cut the policy rate.
    •  As per the latest Union Budget, the fiscal deficit is estimated to moderate from 9.5 per cent of GDP in FY21 to 6.8 per cent of GDP in FY22.
    • This expected decline in fiscal deficit is not on account of lower fiscal spending but because of expectations of sharper revenue growth.
    • The revenue receipts are estimated to grow by 15 per cent and fiscal spending by 1 per cent this financial year.
    • With the debt to GDP ratio already more than 90 per cent, additional fiscal expansion will not be an easy choice for the government.

    Government need to create fiscal space

    • Extraordinary times call for extraordinary measures and the government will have to find ways to create fiscal space.
    • This has become especially important as the economy is yet to shrug off the impact of the previous lockdown.
    • Under these difficult circumstances, immediate measures must aim at providing the requisite social safety net to the poor and the vulnerable.
    • The central government has already announced it will distribute an additional five kg of grain to the 800 million beneficiaries of the National Food Security Act, which is welcome.
    • However, given the unprecedented uncertainty brought about by this COVID wave, the ration support under the PDS should be raised further.
    • The government should also consider transferring cash to the bank accounts of the poor, just as it did last time.
    • This becomes important as MGNREGA  may not provide the safety cushion that it is indeed to as long as lockdown measures remain in place.
    • The best stimulus perhaps would be to provide free vaccinations to the population as the benefits of faster and wider vaccine coverage more than outweighs its monetary cost.
    •  Immunisation is a public good. As we get over this crisis, the government must increase its outlay on physical and human health infrastructure.

    How to finance additional cost?

    •  Part of this additional cost may be financed by reducing non-essential government expenditures and use it for COVID-related expenditure.
    • The government may need to resort to additional borrowings from the market than budgeted earlier.
    • The RBI may allow inflation above the upper bound of 6 per cent only in the short run.
    • The plausible rise in interest rates may also be crucial to prevent capital outflows, given the global “economic outlook” when the US economy adopts an easy monetary policy combined with a huge fiscal stimulus.

    Conclusion

    The government should not be deterred by a worsening fiscal deficit in the short run as the additional growth that it generates may make debt consolidation easier when things normalise.

  • Factors driving FDI in India

    The article explains the four factors that explain the FDI inflows in India.

    India’s economic decade

    • Almost every major global company is either contemplating or operating on the assumption that India is a key part of their growth story.
    • Google, Facebook, Walmart, Samsung, Foxconn, and Silver Lake have been just a handful of the firms that made huge investments in Inda.
    • As a result, India saw the fastest growth in Foreign Direct Investment (FDI) inflows among all the major economies last year.
    • Meanwhile, India’s latest FDI totals still lags behind the highest tallies in other markets such as China and Brazil.

    Issues faced by investors and factors driving investment

    • Frequent shifts in the policy landscape and persistent market access barriers are standard complaints levied against India by the business community.
    • The government’s push to build a “self-reliant” India has also rattled skittish investors and smaller companies that lack the resources to navigate on-the-ground hurdles.
    • Still, investors recognise that doing business in India — or any emerging market  — comes with inherent risks but that adaptation in approach is critical to success.
    • Four core dynamics drive this calculus and explain why multinational companies are making India an essential part of their growth story.

    4 Factors driving FDI in India

    1) India’s population

    • What India offers through its nearly 1.4 billion people and their growing purchasing power is uniquely valuable for multinationals with global ambitions.
    • No other country outside of China has a market that houses nearly one in six people on the planet and a rising middle class of 600 million.

    2) Shifting geopolitics

    •  Rising U.S.-China competition is forcing multinationals to rethink their footprints and production hubs.
    • Savvy countries such as Vietnam have capitalised on this opportunity to great effect, but India is finally getting serious about attracting large-scale production and exports.

    3) Digital connectivity

    • Cheap mobile data have powered a revolution across India’s digital economy and connected an estimated 700 million Indians to the Internet.
    • More than 500 million Indians still remain offline, this is a key reason why leading global tech companies are investing in India and weathering acute policy pressure.
    • Domestic Indian companies have also demonstrated their ability to innovate and deliver high quality services at scale.
    • The partnerships and FDI flows linking multinationals and Indian tech firms will continue to unlock shared market opportunities for years to come.

    4) National resilience

    • Despite facing the scourge of the novel coronavirus head on, India has managed the pandemic better than many of its western peers and restored economic activity even before implementing a mass vaccination programme.
    • These are remarkable developments, and yet they speak to India’s underlying resilience even in the face of historic challenges.

    Shared value creation

    • Unlocking opportunities in the Indian market cannot take the form of a one-way wealth transfer.
    • Companies need to demonstrate their commitment to India.
    • Successful companies do this by placing shared value creation at the heart of their business strategy.
    • They tie corporate success to India’s growth and development.
    • They forge enduring partnerships and lasting relationships, elevate and invest in Indian talent, align products with Indian tastes, and ultimately tackle the hardest problems facing India today.

    Consider the question “Despite the issues faced by the investors, India witnessed the fastest growth in the FDI inflows among all the major economies amid pandemic. In light of this, examine the factors driving the FDI in India.”

    Conclusion

    For leading companies with global ambitions and a willingness to make big bets, the rewards of investing in the Indian market are substantial and well worth pursuing.

  • An effective plan to monetise government assets

    The article discusses the government’s proposal to monetise assets and proposes the idea of an independent commission to carry out the task of monetisation.

    Roadmap for monetisation of asset: National Monetisation Pipeline

    • Finance Minister had introduced a roadmap for monetisation of asset in the Union Budget.
    • In the budget, the government proposed to launch a ‘National Monetisation Pipeline’ to assess the potential value of underutilised and unused government assets.
    • A number of countries including the United States, Australia, Canada, France and China have effectively utilised this policy.
    • In India too, the concept was suggested by a committee led by Vijay Kelkar on the roadmap for fiscal consolidation in 2012.
    •  The committee had suggested that the government start monetisation as a key instrument to raise resources for development.
    •  It asked the government to use these resources for financing infrastructure needs.

    Why monetisation

    • The global pandemic forced the government to increase spending.
    • Thus, total expenditure of the government has jumped to ₹34.50 trillion against the target of ₹30.42 trillion.
    • On the flip side, revenue of the government is shrinking.
    • As a result, total borrowing has increased by 2.3 times, from ₹7.96 trillion to ₹18.49 trillion.
    • An increase in borrowing also increases interest cost.
    • The ratio of interest payment to revenue receipts was 36.3% in 2019-20.
    • As per revised data, it has increased to 44.5% in the current fiscal year and is projected at an all-time high of 45.3% in 2021-22.
    • Almost half of the revenue is going towards servicing old debts. To revive the economy, capital expenditure is indispensable.

    National Infrastructure Pipeline

    • In this backdrop, the government has already launched the National Infrastructure Pipeline (NIP), with 6,835 projects in December 2019.
    • The project pipeline has been increased to 7,400.
    • The NIP has its own specific target and the government is committed to achieve it in the coming years.
    • It called for a major increase in funding.
    • For 2021-22, the government has proposed to spend ₹5.54 trillion, which is 34.5% higher than the budgeted amount of 2020-21.
    • Now, the government found that monetisation of government- and public sector-owned assets would be an important financing option for new infrastructure construction.

    Model for monetisation of asset: REITs

    • The government is looking at the Real Estate Investment Trusts (REITs) model for monetisation of assets.
    • Under REITs, the land assets are transferred to a trust providing investment opportunity for institutional investors.
    • The government has another option to lease or rent out the assets instead of going for monetisation.
    • The government expects monetisation will generate ₹2.5 trillion in non-debt capital revenue.
    • The objective of asset monetisation is to raise resources for future investment into the sector.
    • A pipeline monetisation plan for Indian Oil, GAIL, and Hindustan Petroleum has been drawn up by the government.
    • It is expected that the government will raise ₹0.17 trillion by selling stakes in these three companies.

    Consider the question “What is asset monetisation? What strategy should be followed by the government in the monetisation of assets?

    Conclusion

    To handle effectively the task of monetisation of assets, the government should constitute an independent commission clothed with requisite powers and staffed by professionals and researchers to formulate and implement its monetisation initiative.

  • State budgets belies the hopes of public-spending-led recovery

    The article highlights the trends emerging from the State budgets which dashes the hopes of public-spending led economic recovery.

    State-level budget trends

    • Over the past few weeks, several state governments have presented their budgets for the financial year 2021-22.
    • The states, put together, account for a larger share of general government spending than the Centre.
    • States’ spending stance is pivotal to the hopes of a government spending-led economic recovery.

    5 Broad trends from the state budgets

    • The broad state-level budget trends are based on 11 states that account for a little over 60 per cent of India’s GDP.

    1) Offsetting the additional spending by Centre

    • There is a collapse in states’ revenues and transfers from the Centre.
    • Along with it, there is a “reluctance” among some states to borrow more to spend.
    • Thus, the aggregate level spending by these states in 2020-21 will end up being lower than what they had budgeted for before the onset of the pandemic.
    • The revised estimates peg their total expenditure to decline by around 6 per cent in 2020-21 from their budget estimates.
    • If these trends were to hold for the other states as well, then it would imply that the additional spending by the central government, over and above its budget estimate is likely to be offset by the decline in spending by states.

    2) From revenue surplus to revenue deficit

    • This year, states which typically run revenue surpluses will run revenue deficits.
    • The collapse in revenues meant that states that usually borrow to finance capital expenditure have had to borrow to finance their recurring expenditure (revenue expenditure) as well.
    • As a consequence, capital spending by states has been cut sharply.
    • States, though, expect the situation to reverse in the coming fiscal year, with most projecting a return to revenue surpluses even as the Centre will continue to run revenue deficits.
    • This anomaly is unlikely to be resolved unless the root cause of the situation — the nature of the fiscal compact between the Centre and the states — is addressed.

    3) Reluctance by states to borrow

    • The Centre had raised the ceiling on their market borrowings from 3 to 5 per cent of GSDP.
    • Of this 2 percentage point increase in the borrowing limit, part was unconditional while the remaining was subject to fulfilling Centre-mandated reforms.
    • As per ICRA’s estimate, 17 states qualified based on the One Nation One Ration Card reforms, 15 qualified based on the ease of doing business reforms, seven partially completed power sector reforms, while six had completed the urban local body reforms.
    • But, it is only the low-income states of Bihar, Rajasthan and Madhya Pradesh with already stretched finances that seem to have availed the additional borrowing space.
    • The high-income states of Gujarat, Maharashtra and Karnataka, all of whom had greater fiscal headroom going to the crisis, and were better placed to borrow more and spend, have not done so.

    4) Aggressive fiscal consolidation

    • As is the case with the Centre, states have, remarkably, budgeted for aggressive fiscal consolidation next year.
    • The average fiscal deficit across these states is expected to fall by more than 1 percentage point of GSDP, more than twice the decline recommended by the 15th finance commission.

    5) Ambitious revenue assumptions

    • The aggressive consolidation next year is expected to be achieved not by expenditure compression, as is the case with the Centre, but by significant revenue enhancement.
    • However, some revenue assumptions are quite ambitious, to say the least — some states have pegged their GST and VAT collections to grow far in excess of 30 per cent in 2021-22.
    • A deterioration in fiscal marksmanship will mean that expenditure in the coming fiscal year will also end up being lower than what has been budgeted for.

    Consider the question “The pandemic has upended the States’ fiscal space, which is evident in their budgets. In light of this, examine the trends emerging from the budgets of the States and their implications for the economy.”

    Conclusion

    Subdued general government spending during these tumultuous years heightens the risks to economic recovery. Considering the possibility of the economy exiting from this period with lower medium-term growth prospects, there is a strong case for greater government spending during these years.

  • A changing fiscal framework

    The article examines the changes in government’s fiscal policy stance which supports the debt-financing and apparent contradiction displayed by increased excise duty.

    Increase in excise duty

    • Well before India began to globalise there was a time when each Union Budget announced sales tax increases on tobacco products.
    • The rise in tax was expected to be a shot in the arm for the revenue-starved government of our poor country.
    • India is less poor now, having risen to the rank of an emerging market economy.
    • Yet, COVID-19 has wreaked havoc.
    • As opposed to a Budget estimate of 3.5% for fiscal deficit, the revised estimates show a 2.7 times larger deficit of 9.5% for FY 2020-21. 
    • A comparison of the government’s revised Budget estimates with the original Budget estimates reveals a fall in receipts from every source of taxation except excise.
    • The revised Budget shows a rise of ₹94,000 crore on account of excise duties alone.
    • Presumably, the increase comes from the much-debated excise duty increases on petroleum and diesel.
    • The excise duty rise will hardly compensate for the huge falls in other tax revenues.
    • The larger excise duty collection is not large enough to have significantly reduced the inflated fiscal deficit figure.

    Implications of hike in excise duty

    • Given the nature of the products on which the excise duty has gone up, prices of commodities will rise in general.
    • With annual output shrinking by an estimated 7.7%, it is straightforward to conclude that unemployment has risen significantly.
    • The accompanying price rise will be the unemployed persons’ worst nightmare.
    • The result will be severe inequality.

    Change in economic policy framework

    • The Economic Survey 2020-21 considers Olivier Blanchard’s prescription that a fiscal deficit automatically transformed to government debt.
    • Such debts along with their servicing liabilities have a tendency to magnify over the years where present borrowings keep increasing to repay past borrowings and service charges.
    • This leaves little room for growth-enhancing expenditure and reduces a government’s creditworthiness in the eyes of lenders.
    • Debt-financed fiscal spending could well be a driver of growth.
    • It can improve the standard of living of the entire population, without necessarily removing inequality.
    • A government’s fiscal expenditure, Professor Blanchard points out, has stronger multiplier effects during recessions than during booms
    • The inequality, however, could well be benignant, for even though the rich will grow richer, the poor will escape out of poverty.

    Condition for debt-financed fiscal spending

    • Debt or the fiscal deficit constitutes the government’s spendable resources.
    • What will prevent the government from sinking into a debt trap?
    • Professor Blanchard shows that the debt-to-GDP ratio can be prevented from exploding if the rate of growth of GDP happens to be higher than the sovereign rate of interest.
    • This is the case in developed economies.
    • In such economies, debt financed government expenditure will create a positive primary surplus out of which interest payments can be made to keep the debt-GDP ratio under control.
    • There will, of course, be a maximum value that this ratio can attain, a value that is higher the larger is the excess of the growth rate over the interest rate.

    Contradiction in fiscal policy and fiscal regime

    • According to the Economic Survey, India’s average interest rate and growth rate over the last 25 years (leaving out FY 2020-21) have been 8.8% and 12.8% respectively.
    • Hence, Professor Blanchard’s condition is satisfied.
    • This, of course, is not to support excise duty increases, for it goes against the very principle of the Blanchard argument.
    • Therefore, there appears to be a contradiction between the government’s announced fiscal policy stance and the fiscal regime it is actually running.

    Consider the question”The Economic Survey 2020-2021 calls for the debt-financed fiscal spending. Do you think that this view is suitable for India economy? What are the risks involved?”

    Conclusion

    The government must consider the implications of increased excise on the economy and should focus on removing the contradiction in its fiscal policy and fiscal regime.

  • Tax regime change

    Article explains the measures adopted in the Budget 2021-22 for increasing compliance and transparency.

    Maintaining the status quo

    • COVID-19 has upset fiscal maths around the world.
    • It is in this context that the Union budget assumed significance this year.
    • The expectations of tax breaks were rife on the presumption that this could boost economic activity.
    • Whereas others called for a tax on stock market gains.
    • Unyielding to such requests, the budget was based on a pragmatic approach to maintain the status quo.

    Why higher tax rates would not help much

    • Nearly 60 per cent of corporate taxes are paid by the 0.06 per cent of the companies belonging to the top income bracket.
    • On the other hand, among individual taxpayers, only 0.17 per cent report taxable incomes above Rs 25 lakh.
    • Therefore, higher taxes would either yield little revenue or adversely affect economic activity.

    Need to shift focus to compliance and greater transparency

    •  For increasing compliance and transparency, significant proposals have been made:
    • 1) Limited the window for reopening the case to 3 years.
    • 2) The introduction of the requirement for an assessment officer to provide facts on the basis of which he/she re-assesses.
    •  3) The faceless Income Tax Appellate Tribunal (ITAT).
    • By making the process of assessment faceless the major causes for litigation are addressed.
    • The limited window of re-opening cases for small taxpayers and due consideration of risk management strategy and the CAG’s observations in carrying out such assessments marks an improvement in the process.

    Dispute resolution mechanism with better interface

    • The Vivad se Vishwas scheme was launched in 2020 to address piling litigation and it is reported that collections under this scheme have been Rs 85,000 crore for 1,10,000 taxpayers.
    • This is a small fraction as compared to the Rs 4.34 lakh crore in corporate taxes and Rs 4.49 lakh crore in income taxes that are locked in dispute.
    • Therefore, a dispute resolution mechanism that allows for better interface between the taxpayer and the department may, in fact, be relatively beneficial.

    Consider the question “Examine the reasons for small tax base in India. Examine the measures adopted in the Budget 2021-22 for increasing compliance and transparency.”

    Conclusion

    The budget estimates suggest that corporate tax and income tax collections are expected to increase by 22 per cent. With an expected growth rate of 14 per cent in nominal GDP, the remaining gains in taxes are presumably expected from higher compliance or realisation of taxes due. Whether this will pan out remains to be seen.

     

  • Infrastructure push now, fiscal consolidation later

    The Budget will aid the growth in the aftermath of the pandemic, however, concerns remain over the fiscal deficit.

    Concerns about fiscal deficit

    • The Budget, taken as a whole, has provided reasonable stimulus to growth through a change in the composition of expenditure and other measures to improve the climate for investment.
    • But concerns remain about fiscal deficit.

    High expenditure growth

    • Proposed growth in central expenditure, both in 2020-21 Revised Estimates (RE) and in 2021-22 Budget Estimates (BE), indicates the extent of contemplated fiscal stimulus.
    • For reaching the projected 2020-21 RE levels, the growth required in the last quarter of the current fiscal year over the corresponding period of the previous year appear extraordinary.
    • This involves transferring on to the Budget, the accumulated food subsidies amounting to ₹2,54,600 crore given to the Food Corporation of India through National Small Savings Fund (NSSF) loans.
    • The balance of subsidies amounting to ₹1,68,018 crore would be the food subsidy pertaining to 2020-21 (RE).
    • This is a desirable change towards transparency.
    • Taking revenue expenditure figures as budgeted and adjusting for the NSSF-accumulated food subsidy amount, the growth is 6.7% in revenue expenditure in 2021-22 (BE) over 2020-21(RE).
    • A good part of expenditure for the last quarter of 2020-21 may also pertain to clearing unpaid dues of various stakeholders including the private sector, autonomous bodies and government-aided institutions.
    • Clearing these payments is desirable and would add to demand.
    • The main expenditure push comes through a budgeted growth of 26.2% in capital expenditure in 2021-22.
    •  Relative to GDP, capital expenditure is expected to increase from 1.6% in 2019-20 to 2.3% in 2020-21 RE and 2.5% in 2021-22 BE, signalling a significant change in priority.

    Increase in receipts

    • Significant increases are planned in non-tax revenues and non-debt capital receipts.
    • This increase is mainly predicated on higher dividends from non-departmental undertakings and spectrum sales.
    • From a contraction of 35.6% in 2020-21 (RE), non-tax revenues are budgeted to grow by 15.4% in 2021-22.
    • In the case of non-debt capital receipts, mainly covering disinvestment, a budgeted growth of 304.3% in 2021-22 stands in contrast with the contraction of 32.2% in 2020-21 (RE).
    • Disinvestment initiatives have so far yielded minimal results.
    • Budgeted increase in the Centre’s gross tax revenues is dependent on nominal GDP growth of 14.4%, with a buoyancy of 1.6 for direct taxes and 0.8 for indirect taxes. 

    Steps towards asset monetisation

    • An important initiative pertains to the launching of a National Monetisation Pipeline.
    • The time lags involved in starting yielding revenue remain unpredictable because of various potential disputes and claims involving government-owned land.
    • A transparent auction process needs to be set up to facilitate suitable price discovery.

    Other institutional initiatives

    • The Budget includes central government’s share to the National Infrastructure Pipeline.
    • However, success of the infrastructure expansion plan would depend on other stakeholders of the pipeline playing their due role.
    • The Budget also proposes setting up of a Development Finance Institution (DFI), to serve as a catalyst for facilitating infrastructure investment.
    • The DFI would have an initial capital of ₹20,000 crore.
    • In order to manage non-performing assets of public sector banks, there is a proposal to set up an Asset Reconstruction Company (ARC) and an Asset Management Company (AMC).
    • Much depends upon the fine-tuning the operations of these institutions.

    Finance Commission’s recommendations

    • In the action taken report, the Union government has accepted the recommended vertical share of 41% for the States in the shareable pool of central taxes.
    • The government has accepted the Fifteenth Finance Commission’s recommendation for revenue deficit grants, local body grants and disaster-related grants.
    • The scope of revenue deficit grants has been extended to cover 17 States in the initial years.
    • The determination of these grants is not based on equalisation principle although some norms have been used in the assessment exercise.
    • However, the government has put on hold the consideration of State-specific and sector-specific grants including performance-based incentives.
    • The substantive issue pertains to the mode of transfers in terms of general-purpose unconditional transfers against specific purpose and conditional transfers.
    • States had shown a preference for the former mode and it is for this reason that the 14th Finance Commission had raised the States’ share from 32% to 42%.
    • The reduction from 42% to 41% is only on account of the consideration of 28 States excluding Jammu and Kashmir because of its new status.
    • The imposition of cesses which are almost permanent has reduced the shareable pool.
    • In fact, the States’ share in the Centre’s gross tax revenues is only 30% in 2021-22 (BE).

    Way forward

    • The Fifteenth Finance Commission has also proposed a revised fiscal consolidation road map for the Centre and States.
    • The Fifteenth Finance Commission has recommended the setting up of a High-Powered Intergovernmental Group to re-examine the fiscal responsibility legislations of the Centre and States.
    • Giving up the prudential norms will be a wrong lesson to learn from the crisis.
    • The issue of debt sustainability can be certainly re-examined by taking into account the evolving profiles of debt, interest payments, and primary deficits relative to GDP.

    Conclusion

    Fiscal deficit must be related to household savings in financial assets and the interest payments to revenue receipts. It should not be forgotten that in fiscal 2021-22, interest payments to total revenue receipts will be 45.3%, pre-empting a significant proportion of revenue receipts. We must be conscious of the burden of the rising stock of debt.

  • Making Budget work

    The article deals with the marked departures in this year’s Budget and the challenges in realising the changes.

    Three paradigm shifts from past in this the Budget

    1)Increased infrastructure spending

    • The main theme of the budget is a big thrust on infrastructure spending and public investment.
    • If the budgeted numbers are realised, capex would have grown from 1.6 per cent of GDP pre-COVID to 2.5 per cent in two years.
    • With India’s investment/GDP ratio falling by 5 percentage points over the last decade, a sustained public investment push — with its large multiplicative effects — is a much-needed impetus to reinvigorate growth and create jobs.

    Implications of increased spending

    • The certainty sustained public investment is likely to crowdin private investment.
    • The certainty of investment-led employment that is likely to reduce household precautionary savings.
    • However, higher capex spend is being paid for by disinvestment and privatisation.
    • Effectively, non-core public-sector assets that don’t generate positive externalities — and, in fact, potentially distort the sectors they compete in — are expected to be replaced with much-needed physical and social infrastructure.
    • This newly created physical and social infrastructure emanate positive externalities and necessarily suffer from under-provisioning by the private sector.
    • If successfully executed — this will not be a case of selling the family silver to pay a credit card bill.
    • Instead, it will be akin to a productivity-enhancing asset swap on the public sector’s balance sheet.

    2) Shift in the way for financing infrastructure

    • In stark contrast to the PPP model, infrastructure will now be financed off public sector balance sheets and, once operational and viable, will be monetised so as to recycle proceeds into the next project.
    • In theory, this is the appropriate division of public-private risk sharing.
    • It combines the public sector’s ability to better mitigate upstream risk while taking advantage of the glut of global liquidity potentially attracted to downstream projects.

    3) Shift is towards more conservative and transparent fiscal accounting

    • There has been much focus on bringing the Food Corporation of India (FCI) liabilities back on the budget.
    • Less appreciated is the conservatism with which tax revenues have been budgeted for.
    • Revised estimates peg this year’s gross taxes at 9.9 per cent of GDP.
    • But for that to happen, taxes, net of excise, will need to contract by 20 per cent in the last quarter.
    • So it’s very likely gross taxes will end up 0.5 per cent of GDP higher this year.
    • Not only is this a welcome departure from the past when revenues were consistently over-budgeted, but it sets the base for next year.
    • With nominal GDP expected to grow in double digits, it’s likely taxes, net of excise, will experience a higher-than-unitary-elasticity to growth, especially given the increased formalisation that COVID has spawned.
    • Tax collections are, therefore, likely to exceed budgeted levels in 2021-22.
    • It behooves a very uncertain macroeconomic environment and creates some buffer if crude prices keep rising or other revenues don’t materialise.
    • Credible accounting over time will bring down risk premia in bond yields, and paradoxically generate a stimulative impulse.

    Three challenges in realising these changes

    1) Execution challenge

    • The budget’s impact on shaping the macroeconomic narrative will depend on the speed and efficacy of simultaneously building and selling public assets.
    • It will be important, for instance, to front-load disinvestment and strategic sales to take advantage of buoyant equity markets before global central banks become more cautious.
    • With debt likely to rise to almost 90 per cent of GDP this year, it’s now incumbent on all stakeholders to consistently deliver the 10 per cent nominal GDP growth that’s needed to first stabilise debt at these levels and then bring it down.
    • Viewed from this lens, it is a budget where execution is vital.

    2) Withdrawal of the policy support at appropriate time

    • While fiscal policy is being appropriately counter-cyclical at the moment, it must be equally nimble in the other direction.
    • When the recovery gets more entrenched, policy support should be withdrawn with equal speed and alacrity.

    3) Role of monetary policy

    • With fiscal policy playing a primary role, monetary policy must slowly take a back seat.
    • The combination of a more relaxed fiscal path and domestic private sector savings normalising after the COVID surge could result in equilibrium bond market yields rising [fall in the price of bond] — but that is a cost worth incurring for a meaningful public investment push.
    • In the near term, the RBI may focus on ensuring this new equilibrium is reached in a non-disruptive manner.
    • Given the current slack in the economy, it’s understandable if fiscal and monetary are temporarily complementary.
    • But as confidence in the recovery grows, fiscal and monetary must quickly become substitutes — with the RBI progressively normalising liquidity to wardoff financial stability and fiscal dominance concerns — so as to safeguard macroeconomic stability.

    Consider the question “This year’s Budget marked many departures from the past Budgets. However, there are several challenges in realising these departures. What are such departures and identify the challenges in realising them?”

    Conclusion

    The budget must be commended for embarking on important paradigm shifts. But its success, and in turn the sustainability of India’s recovery, will now come down squarely to policy execution and coordination.