Source: IDEAS AND INSTITUTIONS | ISSUE #48
Analysis
Fiscal Policy Between 2014 and 2024
On February 1, Finance Minister Nirmala Sitharaman presented the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) government’s tenth Union Budget. The government anticipates that its expenditure for 2023–24 will remain roughly equivalent to the budgeted amount. In the previous issue of this newsletter, we discussed that with only about 58.9 percent of the budgeted expenditure incurred by November, the government faced a choice: to accelerate expenditure or to aim for a lower fiscal deficit. This budget clarifies that the government has chosen to accelerate its expenditure. The average monthly expenditure between April and November 2023 was Rs. 3.3 trillion, accelerating to Rs. 4 trillion in December, and is expected to further increase to Rs. 4.8 trillion per month between January and March 2024.
The government’s tenth budget makes for an opportune moment to look back at the changes in fiscal policies and institutions from 2014 to 2024. During this time, there were several major institutional changes. To begin with, the introduction of the Goods and Services Tax (GST) in 2017 led to a near-complete overhaul of the indirect tax system. Similarly, expenditure allocation systems underwent a major change owing to the abolition of the Planning Commission. The Fiscal Responsibility and Budget Management Act was overhauled as well, and there has been a shift toward direct benefit transfers in most welfare schemes. There were also major fiscal policy changes. There was, for example, a sharp rise in intergovernmental transfers from union to subnational governments. Corporate tax rates also saw major cuts, and expansive new schemes, such as the Pradhan Mantri Kisan Samman Nidhi (PM-KISAN) and the Jal Jeevan Mission, were introduced.
Suffice it to say that this has been a dramatic decade on the fiscal front. To analyze it further, this essay examines some of the major trends that have characterized this government’s approach to fiscal institutions and policies during this time. We consider the following four aspects to paint a broad picture of this government’s fiscal choices and how they have changed over the years: the approach to fiscal prudence, the use of fiscal policy instruments to promote economic growth, the use of welfare expenditure to achieve electoral gains, and the response to changing patterns of intergovernmental transfers.
On Fiscal Prudence
With respect to fiscal deficits, the government began the decade on a note of restraint and transparency. Over the years, this stance has changed a great deal. The gross fiscal deficit in 2013–14 was 4.5 percent of India’s gross domestic product (GDP). This administration assumed office in May 2014. In its first year, it brought the deficit down to 4.1 percent in 2014–15 and 3.9 percent in 2015–16. In both years, the actual deficit-to-GDP ratio was the same as the budgeted one. There was an emphasis on fiscal consolidation and staying within the deficit limits announced in the budget.
In 2016–17, the government began a practice that grew considerably over the following years, changing its stance on transparency and restraint toward fiscal deficits: to move a part of the borrowing off-budget, some public sector enterprises were made to borrow funds in order to incur expenditures that were earlier directly funded by the government. In 2016–17, off-budget borrowing amounted to about 0.5 percent of the GDP, and the reported fiscal deficit was 3.5 percent of the GDP. This meant that the actual deficit that year was around 4 percent of the GDP.
The 2017–18 budget indicated that the government intended this to be a one-off deviation from the norm. But that was not the case. The reported deficit was 3.5 percent of the GDP in 2017–18, 3.4 percent in 2018–19, and 4.6 percent in 2019–20. In each of these years, however, there was significant off-budget borrowing as well. These amounted to 0.5 percent of the GDP in 2017–18, 0.9 percent in 2018–19, and 0.7 percent in 2019–20. If we take off-budget borrowing into account, the primary deficit as a percentage of the GDP was 0.9 percent in 2016–17, 0.9 percent in 2017–18, 1.3 percent in 2018–19, and 2.3 percent in 2019–20. In addition, between 2017–18 and 2021–22, the government also decided to recapitalize public sector banks to the tune of Rs. 2.8 trillion but financed this through special securities that were issued to public sector banks. These securities were deemed “below the line” and were therefore not reflected in the government’s borrowings.
Essentially, the union government was running large primary and gross fiscal deficits well before the COVID-19 pandemic. Norms of fiscal transparency were routinely eased to make the reported numbers look good. These practices of off-budget borrowing substantially reduced fiscal transparency in those years. Overall, the story that emerged was that fiscal consolidation and transparency were not at the forefront of the government’s priorities, as it was keen to have more flexibility with the use of fiscal powers.
Three factors may have contributed to these decisions after 2017: disappointing receipts collection, a slowdown in the economy, and the government’s strategy of using welfare expenditure to reach potential voters.
In 2017–18, non-tax revenues fell short of budget estimates by about Rs. 1 trillion due to low dividends from the Reserve Bank of India (RBI) and public sector firms, as well as disappointing fees from the telecom sector. In 2018–19, tax revenues fell short of budget estimates by about Rs. 1.6 trillion, primarily because GST collection was well below expectations. In 2019–20, tax revenues fell short of budget estimates by about Rs. 3 trillion. This was also the context in which direct tax disputes between the government and taxpayers rose sharply, perhaps because the government pushed the bureaucracy to raise more tax resources.
The economy slowed down after 2016–17; GDP growth decelerated from 8.3 percent in 2016–17 to 6.8 percent in 2017–18, 6.5 percent in 2018–19, and 3.9 percent in 2019–20. As discussed later in the essay, the government was also using welfare expenditure as a key part of its strategy to reach potential voters. Despite these efforts, the downturn continued between the fiscal years 2016–17 and 2019–20. Then came the onset of the COVID-19 pandemic.
In 2020–21, crisis budgeting necessitated by the pandemic presented an opportunity to consolidate these off-budget borrowings back into the government’s books. In 2020–21, the reported deficit ballooned to 9.2 percent of the GDP. In response to the pandemic, the government increased current expenditures such as rural employment and food subsidy programs and increased capital expenditures. It also provided guarantees for loans to small enterprises, farmers, non-banking financial firms, and others. However, a part of the 9.2 percent deficit was on account of the government’s move to reconsolidate off-budget borrowings from previous years—at least 1.2 percent of the GDP was the additional transfer to discharge off-budget borrowings for food subsidy (see page 191 of the FCI Annual Report 2020-21).
Since 2021–22, off-budget borrowing has essentially been discontinued. This is mainly because expectations around deficits have changed since the pandemic, and the government no longer has a reason to hide its deficit. The reported deficit has declined to 6.8 percent in 2021–22, 6.4 percent in 2022–23, and 5.8 percent in 2023–24 (revised estimates). Primary deficit estimates were 5.7 percent in 2020–21, 3.3 percent in 2021–22, 3 percent in 2022–23, and 2.3 percent in 2023–24.
The central government’s liabilities rose from 48.3 percent of the GDP in 2016–17 to 60.8 percent of the GDP in 2020–21 and are expected to be 56.9 percent in 2023–24. If nominal GDP growth is good, debt dynamics may not lead to a crisis. In the event of a slowdown, however, the government may find itself in a predicament. In 2023–24, interest payments amounted to about 39 percent of the revenue receipts, and in 2024–25, they are budgeted to be 40 percent.
The fiscal and primary deficits are budgeted to be 5.1 percent and 1.5 percent of the GDP, respectively, in 2024–25. However, as the aforementioned discussion indicates, the actual deficit would depend on whether or not the government sees a need for adjustment in fiscal policy throughout the year. In the past, it has been open to relaxing fiscal targets and even compromising on fiscal transparency when it felt the need to do so. Further deliberation is warranted to ascertain an appropriate fiscal policy for the years ahead.
On Fiscal Policy and Growth Strategy
During its early years, the current government seems to have believed in a rather limited role for fiscal policy in promoting economic growth. Over time, however, many fiscal policy instruments came to the forefront of its efforts to boost growth. A variety of such instruments with the direct objective of boosting investment and growth have been implemented or are being implemented. These include, inter alia, production-linked incentives (PLIs), an increase in capital expenditure by the government, and cuts in corporate tax rates.
In September 2019, the government announced tax cuts for new manufacturing enterprises. Those established after October 1, 2019, were given the option to pay income tax at a rate of 15 percent. However, this rate applied only if they did not avail of any exemptions or incentives and commenced production on or before March 31, 2023 (a deadline that was later extended to March 31, 2024). Additionally, the tax rates of other companies were reduced to 22 percent, provided they also did not avail of any exemptions or incentives.
The government has announced PLIs for many sectors since 2020. These incentives are meant for firms whose applications have been accepted and who have met the targets given in the scheme guidelines. Initially, the PLI schemes were focused on key starting materials, drug intermediates, active pharmaceutical ingredients, large-scale electronics, and medical devices. Later, they were extended to eleven more product categories.
Since 2021–22, a dramatic shift has occurred in the composition of expenditure. The share of capital expenditure in the government’s total expenditure rose from 12.2 percent in 2020–21 to 21.2 percent in 2023–24 (revised estimates) and is budgeted to rise to 23.3 percent in 2024–25. Most of this increase is coming from the roads and bridges, railways, and communications sectors.
On Welfare Expenditure and Electoral Strategy
Fiscal policy has also been crucial for its electoral strategy. The government has made far-reaching changes to how welfare schemes are structured, financed, and implemented, laying a strong emphasis on claiming credit for these schemes. This characteristic had been lacking before 2014, as subnational governments would often receive significant credit for schemes that were substantially or even fully funded by the union government.
The BJP government has prioritized providing cash and basic amenities such as housing, toilets, LPG, electricity, and piped water connections. The expenditure on housing has increased significantly, reaching more households in rural and urban areas. Additionally, schemes like the Swachh Bharat Mission have resulted in the construction of millions of toilets. Another notable scheme is PM-KISAN, which provides cash transfers to farmer households. In recent years, around 90 million households have routinely benefited from this scheme, particularly in states with low farmers’ incomes, like Uttar Pradesh. Overall, these initiatives have aimed to improve living conditions and support farmers. Meanwhile, the provision of cash and private goods works to ensure that the government receives adequate recognition for its efforts.
The BJP government has also significantly expanded the Direct Benefit Transfer (DBT) system as its primary method of disbursing benefits. Initiated using the foundational elements of Aadhaar identification, zero-balance bank accounts, and mobile connectivity already in place before 2014, the DBT system’s reach and efficiency have notably increased. From transferring Rs. 73.7 billion to approximately 108 million beneficiaries in the fiscal year 2013–14, the figures escalated to Rs. 2.4 trillion in cash to 706 million beneficiaries and Rs. 1.4 trillion in-kind benefits to 741 million beneficiaries in 2019–20. The pandemic period saw further expansion, with Rs. 2.97 trillion in cash transfers to 980 million beneficiaries in 2020–21, alongside significant in-kind benefits. The system enhanced the government’s direct engagement with beneficiaries, ensuring that it received more recognition for the schemes. Moreover, the DBT infrastructure significantly improved the government’s capability to respond swiftly and efficiently to crises like the pandemic, facilitating rapid scale-up in benefit distribution without substantial leakages.
On Intergovernmental Transfers
Another area of fiscal policy that has undergone dramatic changes in the last decade is that of transfers to subnational governments. Soon after the BJP-led government came to power in 2014, the Fourteenth Finance Commission submitted its report, recommending, inter alia, that the states’ share in the divisible pool of the union government’s tax collection be raised from 32 percent to 42 percent. This was the single biggest rise in devolution ever. Even though the government had to implement the report from 2015–16, it has since attempted to create fiscal space for itself by other means.
For one, the union government reduced its share of contributions in centrally sponsored schemes, which are co-financed with the state governments. In most schemes, this led to a doubling of the states’ contribution from 20 percent to 40 percent. The union government also discontinued a few schemes. However, it could not reduce the overall transfers under these schemes, perhaps because it was politically difficult to discontinue the ones that were seen to create benefits for various constituencies. Instead, the government focused on trying to receive better attribution for the benefits these schemes created through the means discussed previously in this essay.
The government also attempted to reduce the devolution of taxes to states mainly by raising cesses and surcharges, which are not shareable with the states. This has led to significant distortions in the tax structure, which can be seen most clearly in the union excise collection. Comparison with the pre-GST era is meaningless because some of the union excise duties were subsumed under the GST. In 2018–19, the share of cesses and surcharges in the collection of union excise duties was 70 percent. But by 2021–22, this share had been increased to 93.5 percent before falling marginally to 90 percent in 2022–23 and to 88.6 percent in 2023–24. It is budgeted to be 88.6 percent in 2024–25. So, only a minute portion of the union excise collection is in the divisible pool.
Still, as we have shown in a recent paper, it is worth noting that the overall transfers to subnational governments have remained largely resilient, even though their composition has changed over time. In 2023–24, as per the revised estimates, the total transfers are expected to be 60.9 percent of the union government’s gross tax receipts—32 percent as devolution and 28.9 percent as other transfers. This is more than 10 percentage points above the transfers during the pre-2015–16 era. There are several reasons for this resilience: the continuation of transfers under centrally sponsored schemes; the addition of new types of transfers, such as assistance to states for capital expenditure; a limitation of the strategy of raising cesses and surcharges, given the limited applicability of union excise duties; and the Fifteenth Finance Commission’s recommendations on continuing intergovernmental transfers.
What’s Next for Fiscal Policy?
Going forward, a key question for the government is the path it will take toward fiscal consolidation. It must find a path toward achieving a small primary surplus in the medium term. If the economy is indeed growing reasonably well, there is no cause to run large primary deficits. To reach this primary surplus, the government must achieve a consolidation of at least two percentage points soon. If it meets the targeted primary deficit of 1.5 percent next year, it could aim to achieve a zero primary deficit by 2027–28, provided there is no crisis in the economy.
Reaching this goal depends on several decisions. For 2024–25, the fiscal consolidation is budgeted to occur almost entirely from a cut in revenue expenditure. The sharp rise in deficits in the post-pandemic era allowed the government to increase capital expenditure without seriously constraining its space for revenue expenditure. But in the government’s pursuit of further fiscal consolidation, there might be limits on how well a reduction in revenue expenditure will work, given that a large part of it is committed. There is also the question of making prudent trade-offs between politically beneficial welfare expenditures and capital expenditures. This calls for serious thinking on expenditure management reforms across the board, with a view to improving the efficiency of expenditures.
In most years, one type of receipt or another has proved disappointing for various reasons. In 2015–16, the increase in devolution to the states reduced the net tax revenue receipts for the union government. As discussed earlier, from 2017–18 to 2019–20, each year saw a significant shortfall on some type of receipt. Overall, non-debt receipts fell from 9.5 percent of the GDP in 2013–14 to 8.7 percent of the GDP in 2019–20. They have recovered to 9.3 percent of the GDP in 2023–24.
While efforts can be made to raise the tax-to-GDP ratio to some extent, they usually yield results gradually. Forcing quick results may create unnecessary pressure on the tax bureaucracy to make undue claims. Similarly, there may be some room to raise non-tax revenues, especially RBI dividends, fees, and user charges. But there as well, it is unlikely that significant results will be achieved in the medium run. As it is, user charges levied on several services, especially in the infrastructure sector, are not coming to the government but are essentially in lieu of government funding.
Non-debt capital receipts merit closer attention in particular. At various points during the last ten years, the government made promises to prioritize disinvestment and privatization for both fiscal and broader economic reasons. In the budget speech for 2016–17, the finance minister announced the government’s intent to pursue strategic sales of public sector enterprises. In 2021, the government announced its intent to privatize two public sector banks and one general insurance company during the year. Neither of these transactions came to pass. The only notable exception to this story is the privatization of Air India. Many of the transactions in the last ten years involved the sale of one public sector enterprise to another. For instance, in 2017–18, the sale of Hindustan Petroleum Corporation Limited to the Oil and Natural Gas Corporation contributed receipts of about 0.22 percent of GDP. While the experience does not support optimism, there is substantial scope in the area of non-debt capital receipts, both for narrow resource-raising purposes and for broader economic gains.
Hopefully, the government will not embark on off-budget borrowing and compromise on fiscal transparency. After all, most of the government debt is held by domestic institutions, many of which are mandated to continue doing so. They are in no position to discipline the government. The only external entities whose views might matter are the rating agencies, who by now must have understood how to interpret the off-budget borrowings and find the full picture regarding deficits.
Note: Except for those for which citations are given, all calculations are based on the data from the Union Budget documents and the Finance Accounts.