India Budget – Finer Details of the Delicate Act

As expected, the central government increased its headline fiscal deficit target to 3.8% of GDP in FY20 and 3.5% in FY21 owing to slower than anticipated receipts. A heavy expenditure boost was absent, given lesser household financial savings available to fund the fiscal deficit. While the jury is still out whether to consider the slip this year as a fiscal stimulus or just the outcome of a slowing economy, there is more consensus on higher stimulus in FY21 owing to greater contribution from asset sales. The RBI has acknowledged the budget’s emphasis on boosting the rural economy & infrastructure and the likely support for demand from personal income tax cuts. However, the underlying accounting details that helped the government achieve the headline deficit numbers warrant greater understanding of their likely economic impact.

The tax revenue growth rates assumed for FY21 appear sanguine but are entirely contingent on the government’s FY20 estimates which seem higher based on actual collections so far and typical January-March buoyancy. A shortfall in FY20 automatically pushes up the FY21 revenue growth estimates. Secondly, states could be in a tight spot as they will receive a lower amount this year due to adjustment of excess payment in FY19 and are also unlikely to receive adequate GST compensation, which makes a quick and meaningful increase in GST-buoyancy critical. All this could make meeting the targeted fiscal deficit and funding it a delicate act. Although reliance on off-budget spending and off-market borrowing has increased, FY21 food subsidy through the budget has already been cut and higher NSSF funding factored in, leaving lesser room for year-end maneuvers. Further NSSF-funding space could also be limited and one needs to keep an eye on the higher primary deficit and the total off-budget spending, not just the government-defined EBR.

Budget estimates – a repeat of FY19?

Revenue assumptions in the July 2019 budget (presented based on FY19RE) ended up being optimistic and the FY19 fiscal deficit was met through expenditure cuts. We could see a repeat of this in FY20, albeit to a different extent, as the Jan-Mar share of collections assumed by the government is high (39% for corporate tax vs. 36% in FY19 and 43% for income tax vs. 36% in FY19). This could be a tough ask, despite the direct tax amnesty scheme announced, which could push up FY21 revenue growth rates required (Figure 1). A mild offset could be a shortfall lesser than Rs. 40,000cr anticipated from personal income tax cuts.
Tax collection buoyancies (ratio of revenue growth to nominal GDP growth) assumed are higher. FY20 income tax buoyancy is assumed to be 2.4 vs. 1.4 in FY19 and GST tax buoyancy is estimated to rise from 0.7 this year (actual could be 0.6) to 1.2 next year. This could be a big ask, pending resolution of issues with GST structure and processes (more on this below).
If such a shortfall occurs, fiscal targets may have to be met through higher expenditure cuts and off-budget spending in FY20 and FY21. The former would be pro-cyclical in a slow economy. Moreover, 1) the lever of lower food subsidy transfer at year-end is unavailable from FY21, as part of it is already budgeted to be financed using NSSF and bank loans and 2) non-tax receipts budgeted (telecom, disinvestment) are very high, making the margin for error in FY21 very small.

Figure 1: Shortfalls – The impact on FY21 estimates if FY20 collections fall short as in FY19

Source: CEIC, India budget documents, IDFC MF Research. Note: 1) FY20projection is our estimate based on Apr-Dec actual data and Jan-Mar numbers based on previous year trends. Income tax projection assumes additional Rs. 40,000cr in FY20 from the direct tax amnesty scheme announced (i.e. 80% of the total Rs. 50,000cr estimated collection from the amnesty scheme till end-June 2020 is assumed to be collected in FY20 itself). 2) BE is Budget Estimate, RE is Revised Estimate and FY21BE-implied is the automatic impact on FY21 from FY20 numbers projected to be lower.

States – Tighter Purse Strings

States have been hit on two fronts. First, an excess Rs. 58,843cr received from central taxes in FY19 (July 2019 budget was presented based on FY19RE which assumed higher tax revenue) is being set-off against states’ FY20 share. While this is legitimate, the amount is higher than previous year adjustments. Further, an opposite case of additional payment to be made to states for Rs. 19,679cr from FY17 seems to have been done only with a two-year lag in FY19.
The timing is also unfortunate given the slowdown in growth and state spending so far this year. During Apr-Dec of FY20, revenue receipts and total expenditure of 19 states grew 6% y/y and 9% y/y respectively vs.15% and 13% during the same period in FY19. This could dampen overall government spending which has supported growth so far, particularly with total state spending being 25%-45% more than the centre’s spending during FY17-FY19 and the central government also planning to cut its expenditure this quarter.
Further, specific states such as Kerala, Telangana and Andhra Pradesh are set to receive lower share of central taxes in FY21 (lower by 56bps, 30bps and 19bps respectively) based on the new formula recommended by the 15th Finance Commission. While certain other states will receive higher amounts, how this would impact states’ overall expenditure in FY21 is to be seen.
Secondly, GST compensation payments are unlikely to be adequate. States were already complaining about delay in payments and the mechanism, when GST cess collections fall short, to ensure their 14% GST revenue guarantee till 2022. However, the budget speech clearly mentions compensation payments hereafter would be limited to cess collections. States have been paid Rs. 1 lakh crore so far in FY20, based on cess collected till September, and the final bi-monthly payment was Rs. 35,300cr. The FY20RE number is Rs. 1.2 lakh crore, implying only another Rs. 20,000cr payment in FY20, and FY20BE is Rs. 1.35 lakh crore. We estimate states are likely to lose Rs. 20,000cr in FY20 and Rs. 43,000cr in FY21 due to this. An added risk is budgeted numbers are based on a more-than-double jump in FY21 GST buoyancy (Figure 2). Recent news suggest higher collections due to better compliance, mainly on input tax credit, but structural & process issues still remain and invoice matching is yet to be fully implemented – GST – Let’s Get Realistic (06 Jan 2020). Any shortfall could exacerbate both the centre’s and states’ woes.
With FY20 borrowing window almost over, expenditure cuts might be the only option for states. However, state borrowing in FY21 could be higher from that envisaged before the budget, other factors remaining constant.

Figure 2: Budget implies a strong jump in FY21 GST collections

Source: CEIC, India budget documents, IDFC MF Research. Note: 1) FY20projection is our estimate based on Apr-Jan collections and Feb-Mar estimates. 2) FY21BE is based on government’s budget estimates.

NSSF – The goose that lays the golden eggs

NSSF helps the government reduce the fiscal deficit and then fund it too, by lending to PSEs (e.g. FCI) on the government’s behalf and issuing securities against its inflows respectively. While the former ranged from Rs. 70,000cr to 1,10,000cr between FY17 and FY21, the latter has increased from 2% of the fiscal deficit in FY13 to 30% in FY21. This has allowed the government to manage its market borrowing, albeit at the cost of higher interest rates and impeding transmission of repo rate cuts.
The immediate question is on the quantum of NSSF inflows (towards savings deposits, savings certificate and public provident fund) required in FY20 and FY21 to meet the application of funds. A quick check from FY17 to FY19 reveals application of funds have exceeded inflows each year, suggesting cash balance and/or redemption from special state securities get utilised. We estimate a required inflow of Rs. 2.6 lakh crore in FY20 vs. Rs. 1.5 lakh crore already collected till December. The additional Rs. 1.1 lakh crore required may not be too difficult, given Rs. 93,000cr was collected during Jan-Mar last year and that select PSB fixed deposit rates were recently slashed. Similarly, for FY21, an inflow of Rs. 2.8 lakh crore could be required. Other factors constant, this reduces the probability of a major NSSF-rate cut, although the RBI’s recent step to introduce longer term 1-year and 3-year term repos could reduce bank deposit rates and help cut NSSF-rates relatively. More importantly, additional space within NSSF for heavier funding could be less.

An eye on the primary deficit and extra budgetary borrowings (EBR)

The primary deficit (fiscal deficit excluding interest payments) is an important indicator of how much an economy borrows to fund its core expenses. This is slated to increase to a six-year high of 0.7% of GDP this year. The planned return to 0.4% next year is based on interest payments increasing by the highest amount in at least 10 years and only a benign rise in fiscal deficit. The former is sticky and the latter tricky!
NSSF lending to PSEs like FCI and the government’s issue of fully serviced bonds has been separately provided as EBR in this year’s budget to improve transparency. This is 0.8% of GDP in each of FY20 and FY21, suggesting the real fiscal deficit is 4.6% and 4.3% respectively. However, if one looks at the central government’s overall off-balance-sheet spending (‘Resources of PSEs’), which nearly doubled in FY18 and has then never come down meaningfully, it is high at 2.4% of GDP in FY20 even after deducting the spending done using PSE internal resources. Share of funding such off-balance-sheet expenditure through NSSF and bank loans has also rising rapidly (Figure 3). This may not be a sustainable option.

Figure 3: Resources of PSEs – composition now heavily skewed towards NSSF and bank loans

Source: CEIC, India budget documents, IDFC MF Research. Note: 1) Others include NSSF, bank loans, etc. 2) ECB is External Commercial Borrowing

Conclusion

If FY20 tax revenues slip, in line with collections so far and share of taxes collected in the March quarter in previous years, FY21 revenue assumptions which currently look benign could start looking steeper. Further expenditure cuts would be pro-cyclical during the slow growth playing out. With GST buoyancy lagging, food subsidy already budgeted lower and very high non-tax receipts assumed in FY21, meeting the FY21 fiscal deficit will be a delicate act.
States’ receipts are hit with excess transfer from FY19 getting setoff this year and GST compensation payments likely inadequate even next year. Support for economic growth from the already-slow state government spending could further reduce and the central government is also slated to cut its expenditure this quarter. A shortfall in GST collections, budgeted assuming a much higher buoyancy in FY21, could add to the woes. State borrowing for FY21 could be higher from that envisaged before the budget, other factors remaining constant.
NSSF funding of PSEs and central government fiscal deficit (application of funds) has been rising sharply and exceeding its annual core inflows. This suggests lesser incremental space for heavy funding, apart from the issue of rising interest cost and impairment of monetary policy transmission. A major NSSF-rate cut is unlikely although there is some scope now, in the light of the RBI’s recent measure to introduce 1-year and 3-year term repos.
Primary deficit this year is high and a lower level next year is based on much higher interest payments but only a benign rise in fiscal deficit. This could prove tricky.
EBR, when including all off-balance-sheet spending through central PSEs is much higher since FY18 and their funding through NSSF and bank loans has increased considerably. Beyond not being ideal, this could be unsustainable given limited space within NSSF.
In the context of such a tight fiscal walk, a meaningful allocation of resources towards financial sector reforms to aid credit growth and thus revive the investment cycle for a meaningful economic recovery and higher potential growth could at the best be slower or in parts.

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