The latest National Income estimates from the CSO released on 5 January 2018 indicate a recovery in economic growth beginning 2QFY18 after a fall in the growth rate for five consecutive quarters. This recovery augers well for the fiscal prospects for the latter half of FY18 and for FY19. The World Bank has also estimated India’s growth rate at 7.3% in FY19 and at 7.5% in FY20 and FY21.
Two features are particularly promising in the composition of growth in 2HFY18: First, there is an investment pick-up reflected in the growth in gross fixed capital formation (GFCF) at 5.9% in 2HFY18 as compared to a five-year low of (-) 0.3% in 2HFY17. Second, growth in exports of goods and services has significantly improved to 7.6% from its recent low of (-) 5.2% in 2HFY16. With the prospects of global economic growth also being buoyant, India’s exports should continue to strengthen in FY19. The only critical constraint is the firming up of global crude prices, which may put pressure on domestic prices, thereby reducing the scope for monetary stimulus.
Due to the falling growth up to 1QFY18 and unanticipated fall in dividends from the RBI, there may be an underachievement of revenues with respect to the budget targets. Present trends indicate that there could be a slippage particularly for non-tax revenues, disinvestment proceeds, customs duties, excise duties from petroleum, oil and lubricants (POL) products as well as GST revenues. The shortfall in receipts would leave the Government with a difficult choice. It would need to consider either allowing the fiscal deficit to slip well beyond the target of 3.2%, thereby compromising on its reputation for maintaining fiscal discipline, or cutting expenditure, thus dampening the ongoing growth momentum. Furthermore, since most revenue expenditures are committed in nature, the larger part of the burden of adjustment would fall on capital expenditure.
The lowering of the nominal GDP number for FY18 from INR16,847,455 crore as assumed in the FY18 Budget to INR16,627,585 crore as per the advance GDP estimate also has implications for the FY19 fiscal deficit. Applying a 10% nominal growth on the FY18 GDP number would take the estimated fiscal deficit for FY19, at 3% of GDP as per the fiscal consolidation path announced by the Government in the FY18 Budget, to INR548,710 crore, which is close to the budgeted magnitude of INR546,532 crore in FY18. Thus, in order to adhere to the fiscal consolidation path and reach the Fiscal Responsibility and Budget Management Act (FRBMA) target, the fiscal deficit number will have to be nearly frozen in absolute magnitude. This may prove to be difficult on the eve of the forthcoming General Elections in 2019 unless there is a significant improvement in the tax-GDP ratio.
A positive trend in the era of the present Government has been the creation of additional fiscal space of more than 2 percentage points of GDP during FY14 to FY17 from (a) a reduction in the budgetary subsidies to GDP ratio of about 1 percentage point and (b) an increase in the Center’s gross tax to GDP ratio of 1.2 percentage points. Expenditure reforms should be continued in the FY19 Budget by downsizing ministries dealing with state subjects as the plan process and the plan grants to states have been discontinued.
Given the turnaround in the growth momentum, the FY19 Budget may do well to strengthen this momentum through focused support to construction, infrastructure, housing and manufacturing. These sectors are not only job-intensive and have the capacity to absorb both skilled and non-skilled labor, but also have strong multiplier effects as they create demand for sectors such as cement, steel, electricity and financial services.
A challenge arises from the rural and agricultural economy, which has proved to be vulnerable as farmers are adversely affected by output and price shocks. In both cases, the result is an income shock. Although farmers have the least capacity to face such volatility, they are subject to considerable income volatility. In order to ensure that their incomes do not fall below a defined minimum threshold, a suitable farmer income insurance scheme may be designed, financed by subscriptions by farmers, insurance companies and the Government. This would be fiscally far more feasible than a universal basic income program.
The FY19 Budget would be the last full-year budget presented by the NDA Government before the 2019 General Elections. While it has been noted that elections are often preceded by a proliferation of fiscal giveaways, the present Government has been very cautious about taking up fiscally costly welfare programs. Given the difficult fiscal situation, it is quite likely that the programs designed for job creation and for uplifting the rural economy would be aimed at maximizing the welfare augmenting and growth supporting effects without imposing heavy costs on the exchequer.
The author of the blog is D.K. Srivastava, Chief Policy Advisor, EY India