The FM has avoided short-term populism, but with interest payments rising over 40%, they are eating into resources that would be better spent elsewhere
Nirmala Sitharaman’s Budget has been widely hailed for achieving what can be called an impossible trinity — increasing capital spending by 33%, slashing income tax, and yet reducing the fiscal deficit. Given that nine state elections are due this year, followed by a general election next year, some feared we would have an election Budget full of giveaways that would threaten long-term finances. Similar fears had been voiced last year with the UP elections imminent. But Sitharaman believes, rightly, that giveaways do not win elections, and so has stuck to the conservative path of steadily reducing a fiscal deficit swollen to unprecedented proportions by Covid. She has avoided short-term populism.
And yet some critics will say that serious problems are simply being kicked down the road, and a long-term financial crisis is building steadily. Economist Prachi Mishra has been at the forefront of those warning that the burden of past borrowing is showing up in an unspectacular but inexorable rise in interest payments that are eating into resources that should be spent on infrastructure, social sectors, and other ‘public goods’. Adjusted for inflation, says economist Jean Dreze, the outlays for mid-day meals and integrated child development are down by 43% and 40% respectively since 2014-15. This is the opposite of populism — too much austerity.
Budgetary resources are being squeezed year after year by rising interest payments. Mishra reveals that for the Centre and states, taken together, the ratio of interest payments to revenue is thrice as high in India as the average for emerging market economies. It needs to be cut by at least one-third.
However, this does not portend any immediate crisis. To sustain a fiscal deficit, real GDP growth should be faster than the real interest rate. That is the case today. India can continue on its current path for years despite long-term risks.
And yet some critics will say that serious problems are simply being kicked down the road, and a long-term financial crisis is building steadily. Economist Prachi Mishra has been at the forefront of those warning that the burden of past borrowing is showing up in an unspectacular but inexorable rise in interest payments that are eating into resources that should be spent on infrastructure, social sectors, and other ‘public goods’. Adjusted for inflation, says economist Jean Dreze, the outlays for mid-day meals and integrated child development are down by 43% and 40% respectively since 2014-15. This is the opposite of populism — too much austerity.
Budgetary resources are being squeezed year after year by rising interest payments. Mishra reveals that for the Centre and states, taken together, the ratio of interest payments to revenue is thrice as high in India as the average for emerging market economies. It needs to be cut by at least one-third.
However, this does not portend any immediate crisis. To sustain a fiscal deficit, real GDP growth should be faster than the real interest rate. That is the case today. India can continue on its current path for years despite long-term risks.
The risky part
Sitharaman’s Budget shows no reversal of the adverse trend. The ratio of the Centre’s interest payments to total revenue was 37% in 2021-22, 40% in 2022-23, and is estimated at 46.3% next year. The ratio of interest payments to tax revenue (net of the states’ share) has similarly risen from 44.6% in 2021-22 to 45.1% in 2022-23 and is estimated at 46.3% next year. Soon, fully half of all tax revenue will be swallowed up by interest payments.
One obvious solution could be more efficient tax collection. The ratio of India’s overall tax revenue (of the Centre and states) to GDP has not risen for years, and the Economic Survey reckons it is 5.5% lower than in comparable countries. Evasion, corruption, and inefficiencies have kept tax revenue low.
To combat this, many tax reforms have been undertaken in the last decade. The biggest was the replacement of thousands of individual taxes by a consolidated Goods and Services Tax (GST). The direct tax side has also witnessed simplification, digitisation, and anti-black money measures to catch evaders. Income tax raids have increased manifold.
But all this effort is not showing up in actual tax revenue. The Budget papers have a chart listing the trend in central tax receipts to GDP over the years. The ratio was 10.1% in 2013-14, rose gradually to 11.2% in 2017-18 (when the economy was booming) and then slid to just 9.8% in 2019-20, the year before Covid. The ratio rose again to 11.1% in 2022-3, and is projected to be the same next year. In sum, all the tax reforms of the last decade have yielded disappointingly low dividends. Something much better is required but no new ideas are on the anvil.
One obvious solution could be more efficient tax collection. The ratio of India’s overall tax revenue (of the Centre and states) to GDP has not risen for years, and the Economic Survey reckons it is 5.5% lower than in comparable countries. Evasion, corruption, and inefficiencies have kept tax revenue low.
To combat this, many tax reforms have been undertaken in the last decade. The biggest was the replacement of thousands of individual taxes by a consolidated Goods and Services Tax (GST). The direct tax side has also witnessed simplification, digitisation, and anti-black money measures to catch evaders. Income tax raids have increased manifold.
But all this effort is not showing up in actual tax revenue. The Budget papers have a chart listing the trend in central tax receipts to GDP over the years. The ratio was 10.1% in 2013-14, rose gradually to 11.2% in 2017-18 (when the economy was booming) and then slid to just 9.8% in 2019-20, the year before Covid. The ratio rose again to 11.1% in 2022-3, and is projected to be the same next year. In sum, all the tax reforms of the last decade have yielded disappointingly low dividends. Something much better is required but no new ideas are on the anvil.
Eye on polls
However, global experience has shown that countries can run much higher deficits and accumulate much more debt than was regarded as sustainable a decade ago. The Maastricht agreement setting up the Eurozone decreed that no member could have a fiscal deficit of over 3% of GDP, a ceiling that has been broken with impunity across Europe. Economists Reinhardt and Rogoff had warned that a debt/GDP ratio of more than 90% could lead to a sharp fall in economic growth. Many western countries now have a ratio twice as high, without causing a crisis.
In India too, we have abandoned the Fiscal Responsibility and Budget Management Act target of 3% of GDP. Instead, we now target the debt/GDP ratio, which is to be brought down to 60%, of which the Centre’s share will be 40% and states’ share 20%. Covid took the ratio soaring to 90% and it is still around 85%. We are nowhere near long-term nirvana.
But, in the words of Keynes, in the long run we are dead. For now, the BJP can celebrate a Budget that has drawn praise from economists and yet has enough goodies to help it in the coming state elections.
However, global experience has shown that countries can run much higher deficits and accumulate much more debt than was regarded as sustainable a decade ago. The Maastricht agreement setting up the Eurozone decreed that no member could have a fiscal deficit of over 3% of GDP, a ceiling that has been broken with impunity across Europe. Economists Reinhardt and Rogoff had warned that a debt/GDP ratio of more than 90% could lead to a sharp fall in economic growth. Many western countries now have a ratio twice as high, without causing a crisis.
In India too, we have abandoned the Fiscal Responsibility and Budget Management Act target of 3% of GDP. Instead, we now target the debt/GDP ratio, which is to be brought down to 60%, of which the Centre’s share will be 40% and states’ share 20%. Covid took the ratio soaring to 90% and it is still around 85%. We are nowhere near long-term nirvana.
But, in the words of Keynes, in the long run we are dead. For now, the BJP can celebrate a Budget that has drawn praise from economists and yet has enough goodies to help it in the coming state elections.
This article was originally published by The Times of India on February 4, 2023.
