How credible is path of improving quality of fiscal deficit going forward?

Centre's fiscal deficit is projected to come down to 5.9% of GDP next financial year from 6.4% in the current financial year

The Union Budget has not only tried to improve upon fiscal consolidation in the next financial year but also projected to improve upon the quality of that move.

While the Centre's fiscal deficit is projected to come down to 5.9 per cent of the gross domestic product (GDP) next financial year from 6.4 per cent in the current financial year, its revenue deficit is expected to fall to 2.9 per cent of GDP from 4.2 per cent over this period.

As such, the revenue deficit is projected to fall by 1.3 percentage points of GDP, while the fiscal deficit would go down by 0.5 percentage point.

Revenue deficit does not lead to asset creation. It means that the government is borrowing from the market to finance its current consumption, whereas the servicing of that debt would fall on future generations.

If a higher portion of the fiscal deficit is due to the deficit on the capital account, it would still make sense because capital expenditure at least leads to asset creation. Even if future generations would service debt, it would lead to asset generation.

However, a larger portion of the fiscal deficit used to be revenue deficit since much of the expenditure on revenue accounts is committed to salaries and pension. For instance, revenue deficit was 65 per cent of fiscal deficit during 2021-22.  This proportion is projected to come down to a bit over 63.3 per cent in the current financial year.

This trend would now change since the revenue deficit would account for 48.7 per cent of the fiscal deficit in the current financial year as the government continues to focus on capital expenditure of the Centre as well as the states.

However, one would argue what is the credibility of this path since numbers relating to the year 2023-24 are projections and in the past there were huge deviations from estimates. For instance, the revenue deficit was supposed to come down to 3.8 per cent of GDP in the current financial year from 4.4 per cent in the previous one. However, now the revenue deficit is projected to come down to 4.1 per cent of GDP in the current financial year, according to revised estimates.

Similarly, revenue deficit was projected to come down to 2.7 per cent of GDP in 2020-21, but it widened to 7.5 per cent in revised estimates and actually came in at 7.3 per cent of GDP as the government became transparent on its various subsidies.

However, experts said the path this time seems credible.

"The fiscal numbers look credible because the step taken this time is a modest 0.5 per cent reduction in fiscal deficit ratio. They will have to be more aggressive in the next two years," said Bank of Baroda Chief Economist Madan Sabnavis.

The government used to give fiscal deficit projections for the next two years in its guide path in the Budget. But now the government is not giving those numbers because the Fiscal Responsibility and Budget Management (FRBM) Act is yet to be amended. However, it said it would try to bring down the deficit below 4.5 per cent of GDP by 2025-26.

For the current financial year, Sabnavis said, given that the economy is slowing down this year, the government had to be conservative with revenue projections and rejig outlays to arrive at this number.

"That’s why the revenue deficit is still high as revenue earnings are growing at a slower rate this time while expenditure is largely committed," he said.

Icra Chief Economist Aditi Nayar said one of the factors that will determine whether the targeted improvement on the quality of expenditure is achieved is the states' offtake of capex loan.

The Budget has projected a 50-year loan to the states at Rs 1.3 trillion for 2023-24. In the current financial year, the previous Budget had projected Rs one trillion of this loan to the states, but it was revised down to Rs 70,000 crore due to lack of absorptive capacity of the states.

Meanwhile, then Finance Minister Pranab Mukherjee came out with the concept of effective revenue deficit in the Budget for 2011-12. Revenue deficit was originally scheduled to be eliminated by 2008-09. However, it was later realised that some of the transfers on revenue accounts from the Centre to the states were meant for generating assets. So the deficit in those sums was taken out from the revenue deficit to come out with the concept of an effective revenue deficit.

Effective revenue deficit was projected to widen from 2.6 per cent of GDP in the Budget Estimates for the current financial year to 2.9 per cent in the Revised Estimates. It is now projected to fall to 1.7 per cent of GDP in the next financial year.