Fiscal consolidation in India

How India can balance fiscal consolidation with growth

Photographic portrait of D.K. Srivastava
D. K. Srivastava

EY India Chief Policy Advisor

7 minute read 24 Jan 2023
Related topics
Tax

Providing fiscal policy support to growth calls for continued emphasis on capital spending. 

In brief

  • For FY24, real GDP growth is estimated in the range of 6-6.5% as compared to 7% in FY23.
  • Despite an expected lowering of growth in GoI’s tax revenues in FY24, there is a need to undertake fiscal consolidation.
  • To ensure sustained economic growth, Budget 2023 should focus on high capex spending as it generates high multiplier effects.

India’s economic growth in a global context

According to the OECD’s projections, global growth fell from 5.9% in 2021 to 3.1% in 2022 and is expected to fall further to 2.2% in 2023, reflecting the effect of the current economic slowdown. In 2023, growth in the OECD countries is likely to fall below 1%. The World Bank has projected a much sharper slowdown in global growth from 2.9% in 2022 and to 1.7% in 2023 with advanced economies projected to grow by only 0.5% in 2023, much lower than 2.5% in 2022.

The projections by key multilateral institutions (OECD, IMF, and World Bank1) for India vary, but are all higher than major advanced and emerging market economies in 2022 and beyond. The OECD projects India’s FY24 growth at 5.7%, the IMF at a slightly higher level of 6.1% and the World Bank at an even higher level of 6.6%. We expect that the negative contribution of net exports to GDP growth may bring down the overall real growth to below 6.5%. A lower export growth also has an adverse impact on the domestic growth drivers due to the related multiplier effects. Using a combination of a real growth of 6.2% and an implicit price deflator (IPD)-based inflation of 5%, we estimate India’s nominal GDP growth in FY24 to be close to 11.5%. The latter is much lower than the corresponding FY23 number at 7.9% due to the recent fall in WPI inflation which has a relatively larger weight in the IPD-based inflation.

Fiscal performance and emerging challenges

According to the CGA data for the first eight months of FY23, GoI’s gross tax revenues (GTR) has shown a growth of 15.5% which is just above the nominal GDP growth of 15.4% estimated for the full year of FY23. If the same growth is maintained in GTR for the remaining four months of the fiscal year, a tax buoyancy of 1.0 would be realized which is higher than the budgeted buoyancy at 0.9. This higher buoyancy is due mainly to the buoyancy of direct taxes which may be estimated at 1.6. On the other hand, the indirect tax buoyancy is likely to be lower at 0.6 as an outcome of global crude price movements which forced the GoI to reduce the union excise duty (UED) rates. 

With this, the GoI’s GTR may be estimated at INR31.3 lakh crore in FY23, exceeding the budgeted magnitude by about INR3.7 lakh crore. GoI’s net tax revenues is estimated at nearly INR2.6 lakh crore higher than budgeted. If the GoI maintains the budgeted fiscal deficit target of 6.4% of GDP, it will get access to additional borrowing amounting to about INR0.97 lakh crore over and above the budgeted fiscal deficit on account of a relatively higher nominal GDP. Thus, total additional resources amounting to INR3.5 lakh crore would be available with the GoI and this would come in handy for covering GoI’ s supplementary demands amounting to a net cash outgo of INR3.25 lakh crore after taking into account any marginal slippages in the budgeted non-tax revenues and non-debt capital receipts (Table 1). On the expenditure side, it is notable that capital expenditure has grown by 63.4% during the first eight months of FY23, reflecting GoI’s emphasis on infrastructure expansion and fiscal policy support to growth.

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The FY24 budget would pertain to the first genuinely normalized economy after the COVID-19 shock. Assuming a buoyancy of 1.0, GoI’s GTR may be estimated at INR34.8 lakh crore in FY24 and net tax revenue at INR24.4 lakh crore. Given these broad magnitudes, the forthcoming Budget should clearly signal restoration of fiscal consolidation while sustaining the growth momentum. We assess that reducing fiscal deficit below 5.7% of GDP in FY24 may involve an undue sacrifice of capital expenditure growth which is much needed in the context of the global slowdown and dependence of India’s growth on its domestic drivers. We estimate that with a fiscal deficit to GDP ratio of 5.7%, an expenditure growth of 6.3% would be feasible which may be differentially apportioned between revenue and capital expenditures favouring the latter. 

 

Towards fiscal consolidation

 

GoI’s policy responses to the COVID-19 shock which mainly affected FY21 resulted in a sharp increase in its fiscal deficit relative to GDP to 9.2%, more than three times the FRBM norm of 3%. In the two succeeding years, fiscal deficit could be reduced to 6.7% and 6.4% of GDP respectively assuming that the budgeted fiscal deficit target for FY23 is achieved. With FY24 being the first post-COVID-19 normal year without any base effects characterizing GDP, it would be best for the GoI to spell out a convincing glide path towards fiscal consolidation.
 

The need for correction in government’s fiscal deficit primarily arises because of the relative profile of savings and investment relative to GDP. Financial savings plus net inflow of foreign capital provide the extent of surplus available for the potential net deficit sectors in the economy which consists of government and non-government public sector and the private sector. Household sector financial saving had averaged 7.9% of GDP during FY18 to FY20 before it increased inordinately to 11.6% in FY21 due to an upsurge in the precautionary motive in the COVID-19 year. Assuming household sector financial saving of about 8% of GDP in a normal year and net inflow of foreign capital of 2.5% of GDP, available resources for borrowing by the net deficit sectors amount to 10.5% of GDP. Providing for a fiscal deficit of 5.7% of GDP for the GoI, and 3% of GDP for the state governments, a balance of 1.8% would be available for the private corporate sector and public sector other than the government. If annual reductions of 0.7%, 0.5% and 0.5% points are targeted in the succeeding three years after FY24, GoI’s fiscal deficit would be reduced to less than 4% by FY27. By this time, a High-Powered Intergovernmental Group may be constituted as recommended by the 15th Finance Commission to examine whether the debt-deficit targets of central and state governments need to be revised relative to the 2018 FRBM norms.

 

Supporting growth in short and medium term

 

Given the relatively lower revenue growth expected in FY24, it may be best to contain the growth of revenue expenditure and continue to emphasize capital expenditure growth as it is associated with higher multipliers. While a constrained export growth will be a major challenge in FY24, domestic manufacturing needs to be encouraged by expanding the PLI list. Two favourable trends relate to the prospect of moderation of global crude prices accompanied by a fall in inflation. This may open up the possibility of reducing some of the relatively large petroleum price linked subsidies. While the GoI has already committed to an expanded free food grain scheme under PM-GKAY, some of the fertilizer and petroleum subsidies may be reduced. There may also be some scope for an increase in UED revenue which is likely to contract in FY23. Infrastructure expansion should continue to be the main priority for government expenditure while continuing to encourage Aatmanirbhar Bharat. The GoI may also need to signal its priority for employment creation. The sector that suffered the most during COVID-19 was trade, hotels, transport, storage et. al. which is employment intensive. This sector would need to be supported through government programs that generate demand specific to these segments. It would also be worthwhile considering whether the rural employment guarantee scheme should be extended to urban areas as has been done by some state governments.


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Summary

The FY24 Union Budget needs to undertake a tough balancing act to ensure that a credible fiscal consolidation path is spelt out while also providing substantive fiscal support to growth.

About this article

Photographic portrait of D.K. Srivastava
D. K. Srivastava
EY India Chief Policy Advisor
A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.
Related topics
Tax

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