Financing The Covid-19 Response: Challenges And Choices
The Covid-19 pandemic has cast a long shadow of uncertainty. It is not clear how long it will take to restore normalcy and revive the economic environment. The only things clear at this juncture are that the damage to the economy is enormous and recovery prolonged; government spending in saving lives, livelihoods, and reviving the economy needs to be voluminous; and financing it would pose severe challenges. The problem is particularly challenging as even without the present crisis, the fiscal situation in the country was under severe strain.
Clearly, public finances at both central and state levels have been under considerable strain. Even as the central government invoked the exception clause and budgeted its fiscal deficit higher by 50 basis points, to limit it to 3.8 percent and 3.5 percent for 2019-20 and 2020-21 respectively, it was clear at the time of budget presentation itself that achieving these targets was impossible. This was because the revenues in the revised estimate for 2019-20 were far too ambitious and the budget estimate for 2020-21 based on the previous year’s revised estimate was far too optimistic.
Doing The Math
The actual tax revenue collections of 2019-20 for 11 months put out by the Controller General of Accounts confirm this. The annualised value of tax collections for 11 months is lower than the revised estimate put out in the budget by 19.2 percent. Taking actual tax revenue collection for 2019-20 as the base, it would require a 33 percent increase to achieve the budgeted estimate of tax revenue for 2020-21.
In fact, the budget estimate was prepared assuming nominal growth of GDP at 10 percent. In the present reckoning, the real GDP estimate for the year may not be in the positive territory at all and nominal GDP may register a measly growth of 4 percent.
In addition, in the prevailing market conditions, it would be impossible to achieve the budgeted disinvestment target of Rs 2.1 lakh crore.
While there will be a substantial shortfall in revenue from the budget estimate, the expenditure is likely to substantially increase.
- First, additional expenditures are required to save lives by ramping up the hospital infrastructure, personnel protection equipment, testing kits, and ventilators.
- Second, immediate relief has to be provided to migrant labourers, the self-employed, and unorganised sector workers who have lost their livelihoods.
- Third, as the coronavirus curve is flattened, substantial additional public spending is required to provide a stimulus for economic revival and relief to the affected sectors.
Some parts of the expenditure will be covered by postponing capital expenditures including those on defence. However, the scope for expenditure switching and postponing is limited.
Thus, the government is faced with a huge slippage in the fiscal target. As mentioned above, the shortfall in central tax revenues could be Rs 5 lakh crore even after taking into additional revenues from keeping the prices of petroleum products unchanged. Of this, central share after devolution to states could be Rs 3 lakh crore. In addition, there would be a shortfall in disinvestment proceeds of at least Rs 1 lakh crore. If an additional expenditure of Rs 3 lakh crore is considered, the slippage in fiscal deficit could be almost 2.5 percent of GDP at the central level alone.
In addition, if the fiscal deficit targets for the states is relaxed by two percent of GDP, we could end up with an aggregate deficit of more than 11 percent of GDP even without considering the off-budget liabilities.
In addition, there will be requirements from public sector enterprises.
Monetising The Deficit
Financing this order of deficit is a major challenge. The household sector net financial saving in 2018-19 was just about 7 percent of GDP and this could have actually come down due to additional cash holdings of the households due to the precautionary motive occasioned by the crisis. When the government itself requires much more than the available borrowing space given by the household sector’s financial savings, the yield curve is bound to go up. Under the circumstances, it may be necessary to monetise a part of the deficit by the Reserve Bank India directly lending to the government.
In the past, monetisation of the uncovered portion of the deficit of the central government was automatic. This was done by issuing 91-day non-marketable ad-hoc treasury bills to the RBI, which in turn increased reserve money. The build-up of large deficits led to the crisis in 1991 and there were attempts to stop direct monetisation. In 1994, then RBI Governor C Rangarajan entered into the first agreement with the government specifying limits for the creation of ad hoc treasury bills during the three-year period ending 1996-97. Then in 1997, the second agreement with the government was signed between the RBI governor and the Economic Affairs Secretary to completely phase out ad hoc treasury bills from April 1997. A provision was made for ‘Ways and Means Advances”, subject to limits. In order to smoothen the transition, the Government of India was allowed an overdraft, but at an interest rate higher than the rate applicable for Ways and Means Advances. With effect from April 1, 1999, these overdrafts were allowed only for a maximum of ten working days.
Given the large expenditure requirements and limited household sector financial savings, the focus has once again turned to the need for monetising the deficit by direct financing by the RBI due to the war-like crisis at present. Interestingly, the main architect of ending direct monetisation, Rangarajan, in a recent article, has gone on to state, “a fundamental principle of war finance is that nothing should be decided on the principle of finance”. At the same time, while these exceptional times require exceptional responses, safeguards must be provided to ensure that these are not misused through the routine application. It is also important to evaluate the macroeconomic consequences of these actions once the pandemic recedes.
M Govinda Rao was Member, Fourteenth Finance Commission, and is former Director of the National Institute of Public Finance and Policy.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.