When Finance Minister Nirmala Sitharaman rises to present her second Budget on February 1, she will be keenly watched on the measures that will be announced to revive the economy, which is slowing down pretty rapidly. She will also be evaluated closely on how she will fund those measures. Will she stick to the fiscal deficit target of 3.3 per cent of the GDP, that she set in her previous Budget, or simply blow it?

As the government spending stands today vis-a-vis revenue collection, the fiscal deficit has widened far more than what has been budgeted. But that does not necessarily mean that the target will be missed, if one goes by the experience of the previous years. The government has its own ways to ‘magically’ meet the deficit target. More on that later.

For any economy to mature, fiscal prudence is critical. If the government continues to spend way more than its revenues, it will either have to print more currency or borrow from the market to meet the shortfall. Printing currency will fuel inflation and, at times, hyper inflation. Resorting to borrowings will crowd out the private sector and push up the interest rates, which will consequently slow down economic growth.

Meeting the target

In a bid to avoid these scenarios and mandate fiscal prudence, the Government of India passed the Fiscal Responsibility and Budget Management (FRBM) Act in 2003. Its objective was to institutionalise fiscal prudence and reduce the country’s fiscal deficit in such a manner that it gradually moves towards balancing the Budget. India’s fiscal deficit when the FRBM Act was passed was touching 6 per cent of the GDP, and the aim was to cut it by half to 3 per cent by March 2008.

More than a decade, a global financial crisis, couple of economic slowdowns and many amendments to the FRBM Act (which, among other things, reset the date of achieving the 3 per cent target) later, the fiscal deficit as of 2018-19 remained at 3.4 per cent. As per the latest amendment passed in the 2018-19 Budget, the elusive 3 per cent target will now be reached, hopefully, by 2020-21.

As the FM prepares the Budget for 2020-21, she faces — to use the oft repeated cliche — a ‘do or die’ situation. GDP growth has halved in a matter of four quarters, and is at a six-year low of 4.5 per cent. Most macro-economic parameters are adverse. Bank credit growth is at its slowest, core sector performance has shrunk for three consecutive months now, the Index of Industrial Production is down and the investment rate in the economy is the lowest in 11 quarters.

Despite various measures like higher public spending, steep reduction in corporate tax rates and strong infrastructure push, coupled with monetary stimulus from the RBI involving a 135-basis points cut in policy rates, the economy remains stubborn and continues to slow down.

Facilitate spending

The expectation is that the government should now put money in the hands of the people, so that they will spend. That spending will absorb the excess manufacturing capacity in the system and push the industry to take advantage of the lower corporate tax rates and invest in new capacities. This way, the animal spirits will be unleashed in the economy.

If this involves exceeding the fiscal deficit target, so be it — the current situation demands such a move, many argue. The government may well choose that path.

The question is, how will it do this? It may not have the fiscal space to satisfy everyone. Will it cut income tax rates and put more money in the hands of urban people? And if it does so, will they spend? After all, the RBI’s Consumer Confidence Survey shows that consumer confidence is at a 30-year low. The concern here is that, instead of spending, urban consumers may save up, nullifying the government efforts to kick-start the economy.

Should the government then put more money in the hands of the rural population? It can do this by either increasing the allocation to PM-Kisan or the Mahatma Gandhi National Rural Employment Guarantee schemes. It is said that the fall in consumer spend for the first time in 40 years in 2017-18 was due to lower rural consumption. Experts also believe that the chances of rural population spending the money is high.

Overcoming shortfall

Apart from fiscal stimulus, there is another equally critical reason for the government to give up its obsession of fiscal deficit, which is more in letter rather than in spirit of the FRBM Act. Many of its problems today are due to overestimating the revenues and window-dressing the expenditure to meet the target. Last year it optimistically assumed a nominal GDP growth rate of 12 per cent. In the first half of FY20, the nominal growth registered was just 6.1 per cent.

The assumption of a higher nominal growth rate inflated the projected tax collections. If the GST revenue is likely to fall short by ₹40,000 crore, it is because of this. Pushing tax officers to go after the industry to bridge the shortfall will only increase complaints of ‘tax terrorism’.

On the expenditure side, the government has resorted to off-budget borrowings and delaying payment obligations like subsidies, IT refund and so on, to meet the fiscal deficit target. It also cut back its spending for the purpose. But doing so now, when the economy is already heading southwards, will accentuate the slowdown.

This Budget presents a good opportunity for the government to come clean. Blow the deficit to spur growth and at the same time clean its books once and for all. The markets have factored in a possible breach in the fiscal deficit target, and so have the global rating agencies. They are not going to panic and punish. The government will be commended for bring credibility back to its numbers.

And by doing so, the government can start on a clean slate and achieve in the next few years what has been difficult so far — meeting the revised fiscal deficit target fair and square.

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