As Covid wanes, economy back on recovery path

This is the time of year when optimistic budget projections usually prove false, tax revenues fall short of expectations, austerity is decreed for government departments, government dues and capital spending are postponed for want of funds, and budgetary fudging of all sorts begins to try and keep the fiscal deficit close to the budget target. But not this year. Thanks to a booming economy, tax revenue has soared beyond all expectations and the fiscal deficit has plummeted.

The economy has recovered sharply from the traumatic April-June quarter, when Covid’s second wave caused lockdowns and shutdowns. At that time the budget projections looked far too optimistic. The RBI cut its GDP growth forecast for the year from 10.5% to 9.5%, and the IMF reduced its forecast from 12.5% to 9.5%.

But then the second Covid wave receded as quickly as it had risen (save in Kerala). Consequently, the economy bounced back so strongly that earlier GDP and budget projections may turn out to be too pessimistic, not too optimistic.

This will help the BJP when five states go to the polls four months hence. GDP growth is not a key determinant of state elections, but a booming economy is always better than a sluggish one for the ruling party.

The budget estimated the fiscal deficit — net borrowing of the government to finance spending — at a high 6.8% of GDP. When the second wave of Covid struck, rating agency Fitch projected a worsening of the fiscal deficit to 8.3% of GDP. But the latest trend suggests it could end up at maybe 5.8% of GDP, a huge saving.

To understand how remarkable the shrinkage is, recall former finance minister Arun Jaitley’s attempts to get the fiscal deficit down to his target of 3% of GDP. He started in his first year with a fiscal deficit of 4.1%, followed by 3.9%, 3.5%, 3.5% and 3.4% in subsequent years. He just could not get the figure down to 3.0% despite fudging to cloak borrowing by government-owned entities and huge arrears of payment to the Food Corporation of India and others. The economy was slowing in those years, and so was revenue.

But right now, the economy has bounced back sharply, and tax revenue with it. In April-August, revenue receipts were a high 41% of the annual estimate against only 18.3% last year (because of Covid) and 30.7% the preceding year, before Covid.

Credit Suisse estimates that the average in the last 24 years was no more than 28%. Earlier we feared that Covid would depress the long-term trend of collection, but no longer. Compared with the pre-Covid period two years ago, total tax revenue has grown at a compound rate of 16% per year, corporate tax at 23%, excise duty at 34%, and GST at 6%.

Tax buoyancy is the key reason why the fiscal deficit in April-August was only 31.1% of the budgeted amount for the year, against a 24-year average of 57%. Hence Central and State cash balances with the RBI have soared to Rs 4.5 trillion (or 2% of GDP).

Nirmala Sitharaman took over as finance minister in 2019 and slashed the peak corporate tax from 30% to 22% (plus surcharge and cess) for existing companies, and further to 15% for new companies that did not avail of other tax breaks.

This meant a huge short-term loss in corporate tax (Rs 145,000 crore). in the hope that improved buoyancy would make up for this later. That optimism looked a stretch at the time, but the latest figures suggest it may be well grounded.

So, is all well? No, there are several problem areas. Covid has deeply scarred many companies, which are saddled with high debts that they are not able to repay. The risk of sick companies dragging down creditor banks continues.

Big companies have greatly improved their profitability this year while many small and medium companies are in serious trouble. Covid has killed many companies and others are bleeding. The problem is worst in the unorganised sector, which has historically been an important employer.

Privatisation and asset sales have been very slow. Air India has finally been privatised, but this entails the government taking over $6 billion of the company’s debt, which will burden the exchequer.

BPCL, Container Corporation and the Shipping Corporation of India have yet to be privatised almost two years after the intention was announced. Faulty bid conditions meant no bids at all were received for running 109 private passenger rail services.

In sum, there is much hard work ahead for the government if the current spurt in growth is to be sustained. But for now, let us welcome the spurt.

This article was originally published in The Times of India on 10 October 2021.

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