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Issue 8

Budget 2021 and Fiscal Deficit: The Good, the Bad and the Ugly

Finance Minister Nirmala Sitharaman presented the Union Budget for Financial Year 2021-22 on 1st of February 2021. Announcements regarding privatization and asset monetization attracted attention while the accounting treatment of fiscal deficit raised eyebrows even as it found approval from experts.

Fiscal deficit is the difference between the government’s total income and total expenditure. More accurately, fiscal deficit occurs when the government’s expenditure exceeds its income. In the Revised Estimates for FY 2020-21, the headline fiscal deficit number was announced as 9.5 percent of GDP. In the previous budget (for FY 2020-21), the fiscal deficit was targeted at 3.5 percent. This steep revision in fiscal deficit estimates for the current financial year (2020-21) as one of the highlights of the Budget. If we take a closer look at fiscal deficit revision and the path the government wants to take in the future, we find three important points to underline.

The Good

The Revised Estimate for fiscal deficit for 2020-21 actually found approval from experts. Why was it so? This was because of the FM’s announcement regarding how food subsidies are accounted for. The Food Corporation of India (FCI) procures wheat and rice from farmers at Minimum Support Price (MSP) and then sells them at a loss through the Public Distribution System (PDS). The loss that the FCI suffers is on account of the food subsidy that the government provides. Ideally, the Union government is required to allocate funds for this shortfall in the budget, but this was not the case so far. For example, while the FCI suffered losses of over Rs 3 lakh crore in 2019-20, the budget only allocated Rs 75,000 cr. The FCI was forced to borrow the difference from other sources like the National Small Savings Fund. This helped the government exclude the actual food subsidy numbers from its accounts and this shored up the fiscal deficit number. However, the problem was that this made the fiscal deficit numbers suspect. With the announcement this year, the FM has made budgetary provisions for payments to FCI for this financial year on account of food subsidy. In return, the actual subsidy numbers are now reflected in the accounts and this is one of the reasons (but hardly the only reason) for the sharp jump in fiscal deficit for 2020-21 in Revised Estimate. This transparency in accounting is a refreshing change and can be called a good thing in Budget 2021.

The Bad

The Fiscal Responsibility and Budget Management Act (FRBM Act), 2003 was introduced to bring transparency and discipline to India’s fiscal policy. The Act stipulated that the Union government will reduce its fiscal deficit to 3 percent of GDP by the end of FY2020-21. Abiding by FRBM rules that have helped the governments over the years burnish their credibility among rating agencies. FRBM Act also provided the government exemptions on account of national security, calamity, etc. While announcing the Union Budget for 2020-21, the FM had invoked one of the clauses in FRBM Act to raise the fiscal deficit target for 2020-21 by 0.5 percentage points to 3.5 percent of GDP. This has now been revised to 9.5% in RE 2020-21. As pointed out by Vivek Kaul, the fiscal deficit as a percentage of government expenditure will be at 53.6% in 2020-21. The budgetary provisions for payments to FCI explain only a part of this sharp jump in fiscal deficit in this financial year. The other reasons are a shortfall in tax collection, much lower than expected receipts from disinvestment, and a shortfall in non-tax revenue. While the transparency in budgetary accounting is good, it does not hide the fact that the fiscal deficit is way above the FRBM target.

The Ugly

The FRBM Act, 2003 did not just have a fiscal deficit as its target. One of the foremost targets of the Act was the reduction and eventual elimination of the revenue deficit. This meant that the 3% target for fiscal deficit would be used to fund capital expenditure only. Revenue deficit is when the government’s total revenue expenditure exceeds its total revenue receipts. Expenditure incurred on payments of salaries, pensions etc. is classified as revenue expenditure while expenditure on building assets like roads, waterways, rail lines, factories, etc. is classified as capital expenditure. 
FRBM Act sought to eliminate revenue deficit so that any deficit would be on account of capital expenditure only. This is because capital expenditure has a 2.5 multiplier effect on the economy while the multiplier effect for revenue expenditure is only 1 (Sukanya Bose and N.R.Bhanumurthy – NIPFP). FRBM Act thus encourages the government to switch from revenue expenditure to capital expenditure. In 2018, the government stopped targeting revenue deficit. Instead of eliminating revenue deficit, the government squeezed capital expenditure to meet the fiscal deficit targets. For example, in BE 2020-21, the Union government’s capital expenditure for FY2020-21 was Rs 4,12,085 crore (Gross Budgetary Support) while the in RE 2020-21, this figure has actually gone up to Rs 4,39,163 crore (Budget at a Glance, Page 8). In RE 2020-21, the revenue deficit is projected to climb to 7.5%. For FY 2021-22 (according to Budget Estimates 2021-22), capital expenditure (Gross Budgetary Support) is projected to increase by 26.2%.

Source: Union Budget 2021

This squeeze on capital expenditure while not targeting revenue deficit as laid down in the FRBM Act is the ugly part of how fiscal deficit numbers have played out over the last few years.

To be fair, the government has increased the budgetary support for capital expenditure for FY21-22 to Rs 5,54,236 crore (BE 2021-22). This would take total capital expenditure for 2021-22 to Rs 11,37,067 crore. To put things in perspective, the revenue deficit estimate (BE 2021-22) is Rs 11,40,576 crore and this situation can hardly be called comforting.

Ankur Bhardwaj is Editor, Centre for Economic Data and Analysis (CEDA.) Previously, he was Associate Editor – Web at Business Standard.

Picture Credits: Canva

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