News Bureau

Borrowing Unlikely to Translate into Stimulus

Dr. Devendra Pant, Chief Economist and Head Public Finance inks with Dr. Sunil Kumar Sinha, Principal Economist and Director Public Finance & Amit Jain, Analyst of India Ratings and Research says, Increased Central Government Borrowing Unlikely to Translate into Meaningful Fiscal Stimulus!

India Ratings and Research (Ind-Ra) believes the central government’s announcement of enhancing the gross borrowings to INR12 trillion from the budgeted INR7.8 trillion in FY21 will largely take care of the revenue shortfall, leaving little space for fiscal stimulus, unless the center sharply cuts the budgeted Capex and reprioritizes expenditure.

Revenue Shortfall in FY21: Notwithstanding the low crude prices and increased excise on petrol and diesel, Ind-Ra estimates the gross and net tax revenue of the central government in FY21 to fall short of the budgeted estimate by INR4.32 trillion and INR2.52 trillion, respectively.

As weak economic activities will also have an impact on non-tax revenue, Ind-Ra expects dividend and profit and other non-tax revenue to decline by INR1.48 trillion from the FY21 budget estimate. This means the central government is staring at a revenue shortfall of INR4.00 trillion from the FY21 budget estimate.

Ind-Ra’s calculation also suggests that the central government is unlikely to meet even the revised estimate of FY20 due to the country-wide lockdown. The center’s gross and net-tax revenue is now estimated (best scenario) to be INR1.73 trillion and INR1.20 trillion, less than FY20 revised estimate. This would translate into a revenue shortfall of INR1.62 trillion from the FY20 revised estimate.

Limited Space for Intervention: Ind-Ra expects the revenue shortfall to account for 95.1% of the increased borrowings, leaving a purse of just around INR200 billion for the central government to provide fiscal stimulus. This is too small an amount to make any difference to the sagging economic activities/demand. Clearly, the challenge is huge with hardly any fiscal space, despite an increase of gross borrowing by INR4.2 trillion.

Nonetheless, Ind-Ra believes the onus is on the central government to provide support to not only vulnerable sections of the society but also state governments, because the actual battle against Covid-19 and associated expenditure is incurred by the state governments.

Financial Conditions to Tighten: INR4.2 trillion increase in the gross market borrowings of the central government from FY21 (budget estimates) and INR6.7 trillion gross market borrowings of state governments will increase the supply of government paper in the market. Ind-Ra estimates the net market borrowing of central and state governments in FY21 to be INR14.9 trillion (7.4% of GDP).

The system though has surplus liquidity and the Reserve Bank of India (RBI) is absorbing nearly INR8 trillion in reverse repo window, Ind-Ra expects the financial conditions to tighten and volatility in the financial market to increase in FY21. From 1 March 2020 to 11 May 2020, banks sanctioned loans of around INR6.00 trillion to micro, small and medium enterprises & others.

In a tighter financial market with limited fund availability, the government would crowd out the private sector in the first step and in the second, large borrowers would crowd out small borrowers.

Declining Household Financial Savings; Tighter Financial Conditions: Even before the Covid-19 impact, the Indian economy was staring at a mismatch between domestic savings and investments. Under institutional classification, the economy is divided into four categories - general government, public corporations, private corporations and households.

Households contributes maximum to the gross value addition (44.3% during FY12-FY19), savings (61.1%) and fixed capital (39.2%) in the economy. Moreover, of the four categories, only households have a positive savings-investment gap. In other words, this means that the savings of households finance the investment requirement of the other three categories.

However, the financial saving of households has been declining over the years and was 6.5% of GDP in FY19 compared with 8.1% in FY16. In FY19, households’ financial savings declined to INR12.3 trillion from INR13.2 trillion in FY18.

On the other hand, central and state government borrowings are rising over the years. The net central government, state government and central public sector entities’ borrowings increased to INR18.89 trillion (9.3% of GDP) in FY21 from INR6.19 trillion (7.1%) in FY12.

The gap between net funding requirements of the government sector (center, state, and PSEs) and households’ financial savings has narrowed lately, leading to sustained pressure on the interest rate. As a result, the interest rate has remained elevated and G-sec/SDL yields have not moved in tandem with the policy rate.

Deft Footwork by RBI Can Help: Besides ensuring orderly functioning of the financial market and maintaining ample liquidity in the system, the RBI’s role is important even from the point of view of the government’s cash management and market borrowing program.

Higher ways and means advances and increased Treasury bill issuances can help in countering the short-term volatility in the financial market. Ind-Ra believes the RBI has to play on the front foot and use all instruments such as open market operations; repo rate, operation twist, and currency swap to ensure the fallout of higher borrowings on the interest rate.

Nonetheless Ind-Ra believes the interest rate will remain elevated, and deflecting some the government borrowings towards small savings funds would reduce the interest rate on market borrowings.

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