Over-reliance on market borrowing can lead to a vicious cycle of deficit and debt

The Union Budget for 2021- 22 was presented against the backdrop of a complete collapse of realisation of revenue receipts, particularly tax revenues and disinvestment proceeds, coupled with higher revenue expenditure due to larger provisioning of food subsidies for 2020-21. In addition, there has been an unprecedented contraction of economic growth.

The revival of growth was designed by the government through financing the expenditure (both revenue and capital) by an all-time record level of fiscal deficit (9.5 per cent of the GDP) accompanied by a revenue deficit (7.5 per cent). It is important to mention that the financing of such a level of deficit was met by market borrowings facilitated by massive liquidity support (injection of cash by printing money) by the Reserve Bank of India to the financial system.

It may be a consolation that this development is not unique to India but a worldwide phenomenon. The government is hopeful of a V shaped recovery for the Indian economy with a real growth rate (nominal growth rate minus inflation) of 11 per cent for 2021-22 as against a contraction of 7.7 per cent in 2020-21.

The Union Budget proposals for 2021-22 are based on 6 pillars viz;(i) Health and wellbeing,(ii)Physical & Financial Capital, and Infrastructure (iii) Inclusive Development for Aspirational India (iv) Reinvigorating Human Capital(v) Innovation and R&D and(vi) Minimum Government and Maximum Governance.

Out of these six pillars health, human capital and infrastructure requires higher provisioning of capital expenditure. Recognising this, the Budget has made provision for capital expenditure to the tune of 2.48 per cent of the GDP. Revenue expenditure is budgeted at 13.14 per cent of GDP. Thus, the total expenditure is 15.62 per cent of GDP. The borrowed resources measured in terms of fiscal deficit finances 43.53 per cent and the balance (56.47 per cent) is financed by revenue receipts and non-debt capital receipts. Furthermore, borrowed resources are budgeted to finance the revenue deficit to the extent of 75 per cent and the remaining 25 per cent is budgeted for capital expenditure even though the government claims that the capital expenditure is 26.2 per cent higher than that of 2020-21.

If the government had followed the Fiscal Responsibility and Budget Management (FRBM) Act stipulation of 3 per cent of GDP as borrowed resources, it would have financed only 19.20 percent of total expenditure. This translates to a case for higher share of revenue receipts and non-debt capital receipt to the tune of around 71 per cent as against the budgeted share of around 56 per cent.

Another important aspect is related to human capital expenditure as mentioned earlier. Human capital is essentially health and education expenditure and as per our constitution, basically in the State list. To the extent that State governments will be involved in these areas the Union Budget has increased the borrowing limits of State governments to 4 per cent of the GDP as compared to the present limit of 3 per cent. Thus, the fiscal deficit of the government (Centre plus States) is 10.8 per cent of the GDP.

The lion’s share of such a level of fiscal deficit will be financed by market borrowings. Larger market borrowings will generate higher demand in the market. But the savings of the economy which is the supply side of financing the borrowings is severely limited as the income level in the economy is low and revenue deficit representing the dis-savings of the government is high.

This development will put pressure on the interest rate as well as the quantum of interest payments due to the demand and supply mismatch. Higher interest payments have already been reflected in the budget as it has shown an increase of 16.9 per cent over the previous year thus accounting for around 45 per cent of revenue receipts of the government of India.

The Union Budget has estimated a nominal GDP growth rate of 14.4 per cent for 2021-22 while the gross tax revenues have been budgeted to increase by 16.7 per cent with increases in corporation tax (22.64 per cent), personal income tax (22.22 per cent),customs duty(21.42 per cent) and GST(22.30 per cent). It is important to note that such increases in tax rates and GDP growth are mainly guided by the base effect. Therefore, it gives a spurious tax buoyancy picture.

Now let us turn to the medium-term fiscal road map. The Union Budget is silent on the medium-term fiscal road map. The moot question is how soon the government will return to the FRBM target of fiscal deficit and debt? The fiscal road map critically depends how soon the Indian economy will be on a sustainable growth trajectory path.

The return to sustainable growth as mentioned earlier depends on savings, particularly financial savings and channelisation of savings to investment. The important factor in this regard is the elimination of the revenue deficit which the government has been taking recourse to, by borrowing to finance the current consumption. Thus, revenue deficit is a dis-savings of the government. As long as there is a revenue deficit of a higher magnitude, dis-savings will be higher and the savings of the government will be adversely affected as also investment and economic growth.

The Union Budget has over reliance on borrowing to finance government expenditure. Apart from the interest payments implication as discussed above, there are challenges of crowding out private investment. Government financing of investment expenditure on infrastructure needs to be supplemented by private investment. Infrastructure financing has not been categorical about private sector involvement.

The over reliance on borrowing in terms of a high fiscal deficit will put pressure on the RBI to manage the market borrowing as the debt manager. Already the market borrowing for 2020-21 has been at a record high level and another dose of higher level of borrowing from the market will adversely impact the financial market and prudent functioning of financial institutions particularly banks. This is so as more loanable funds will be directed towards funding the government’s market borrowings resulting in less loanable funds available to provide credit to the private sector.

To conclude, the over reliance of the Union Budget on borrowing will in many ways reap adverse consequences of a vicious cycle of debt and deficit rather than moving the economy to a sustainable growth path.

(Dr. R K Pattnaik is a former Central banker and a faculty member at Bhavan’s SPJIMR. Views are personal) (Syndicate: The Billion Press)