Fiscal sustainability is in question

The tall claims of TEC — transform, energise and clean — touted as the headline theme of the fiscal architecture of Budget 2017-18 fall flat amid serious concerns with regard to the revival of economic growth and fiscal sustainability in a medium-term perspective. In many respects, the Budget suffers from a typical incremental approach rather than being innovative. Further, demonetisation seems to be in focus as a panacea for all economic problems, including revival of growth.

The following questions need to be asked: Will the expenditure pattern and composition revive growth? Is the high reliance on mobilisation of revenue through personal income tax feasible and sustainable? Does the compositional shift from market borrowing to small savings indicate fiscal prudence? Has the medium-term roadmap outlined for the deficit indicators addressed the issues relating to fiscal space and fiscal sustainability?

Expenditure and growth revival One of the budgetary reforms is the removal of Plan and non-Plan classification of expenditure to facilitate a holistic view of allocations for sectors and ministries. It may be noted that there are no reform elements in the classification change; it is only an accounting arrangement. It would have been appropriate had the accounting arrangement been more functional by differentiating the developmental and non-developmental composition expenditure. Nevertheless, going by the allocation figures under different heads of expenditure, it is ascertained that only 16 per cent of the total expenditure is truly investment expenditure (capital outlay excluding defence) which could support growth.

Furthermore, the revenue deficit at 1.9 per cent of GDP is budgeted to predominantly result from higher interest payments. For example, expenditure on interest payments accounts for nearly 25 per cent of the total expenditure, and around 30 per cent of increase in total expenditure is due to interest payments alone. Thus, as far as expenditure components are concerned, there is hardly any headroom for growth revival.

Unsustainable reliance With regard to revenue management, the gross tax revenue has been estimated at 11.3 per cent of GDP. The authorities claimed that the growth in gross tax revenue was estimated to be moderate considering the high base on account of substantial growth achieved in the current year. In BE 2017-18, the growth in gross tax revenues has been estimated at 12.2 per cent over the RE. However, a decomposition analysis of the tax revenues reveals that there is high reliance on the collection from personal income tax. For example, personal income tax receipts are budgeted at 2.6 per cent of GDP, accounting for 23 per cent of total tax revenues, and budgeted to grow by around 25 per cent with a tax buoyancy of around 2.7.

This high reliance is based on the Government’s estimate of revenue gain from demonetisation. But it may be noted that it is a one-time focus and therefore this trend is not sustainable. Thus, the Budget has an erroneous perception and analytical framework that predominance of cash in the economy makes it possible for people to evade paying taxes. On the contrary, it is the weaknesses of the tax administration and structural rigidities in voluntary compliance that are the stumbling blocks.

Apart from this, the persistence of revenue deficit which not only represents the dis-savings of the Government but also pre-empts high-cost borrowed funds questions the very structure of sustainability and revival of growth. The academic literature and evidence suggest that economic growth is a function of investment limited by savings. With dis-savings of 1.9 per cent of GDP and pre-emption of around 60 per cent of high-cost borrowed fund for current consumption, the wherewithal of sustainable revival of growth is a big question mark.

Ambitious disinvestment The disinvestment proceeds are budgeted at ₹72,500 crore, which clearly is over the top. If the past is any guide ( Budget 2016-17 estimated disinvestments at ₹56,500 crore but in RE it lowered the figure to ₹45,500 crore), such high level of disinvestment receipts are hardly achievable. Thus, achievement of the target for fiscal deficit at 3.2 per cent of GDP is doubtful.

The fiscal consolidation framework in terms of the Fiscal Responsibility and Budget Management Act recognises the level of fiscal deficit and not its financing. There are two inherent weaknesses in the financing pattern offered in the Budget: (a) draw-down of surplus cash balance and (b) more reliance on securities issued against small savings schemes.

The former is a result of poor and inefficient cash management by the Government; this needs to be addressed because the surplus cash maintenance with the RBI makes monetary liquidity management difficult as it blocks the headroom with respect to neutral liquidity. In case of the latter, experience tells us that many public sector institutional investors are made to invest in small savings schemes, making the purpose of such scheme meaningless as these are meant for small investors.

Fiscal space Prudent fiscal management justifies the elimination of revenue deficit at the earliest so that the borrowed funds areused for investment expenditure. However, there is no sign of elimination of revenue deficit in the medium-term roadmap right up to fiscal 2019-20. The continuation of primary deficit and financing of interest payments to the tune of around 3 per cent of GDP from borrowed funds question the fiscal sustainability of the Government. Thus, the persistence of a large revenue deficit and the absence of a primary surplus has not provided any leeway to the Government to create an enduring fiscal space.

To conclude, it is important for the Government to address fiscal sustainability in the analytical framework of the fiscal architecture. This will in turn break the vicious cycle of revenue deficit and fiscal deficit, and certainly not demonetisation. Only then will TEC be relevant.

Pattnaik is a professor, and Rattanani the editor at SPJIMR. Via The Billion Press

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