Budget 2020-21 Is Falling Apart- Concluding Part III- Financing Extraordinary 10 Lakh Crore COVID-19 Deficit

COVID-19 Unravelling Union Budget 2020-21- Part III

FISCAL DEFICIT AND FINANCING THEREOF

Budget 2020-21 Is Falling Apart

Budget 2020-21 of the central government has started falling apart even when the financial year has just begun. COVID-19 has struck a massive blow to people, economy and budget. Both sides of budget- revenues and expenditures- are unravelling.

The central government announced a package of Rs. 1.7 lakh crores on 26^th March. This might require about 75000-80000 crores of additional expenditure beyond what was budgeted. Programme for strengthening medical infrastructure has also been announced.

There is growing chorus for more fiscal measures- for supporting businesses especially small informal businesses and millions of workers rendered jobless by the lockdown of economy. The state governments finances have suffered more and they are also demanding packages of support. The central government will sooner or later will have to address these demands.

Revenues are badly hit. Demand for petroleum products has almost collapsed hurting customs and excise revenues. Over 2/3^rd of goods and services producing businesses are shuttered, which will impact GST revenues of April. Slow gradual opening of economy will cast a long shadow on GST revenues, excise duties and customs. Falling corporate profits and pressure on salaries and dividends will affect corporate taxes and personal income taxes.

The Government imposed cuts on 81 out of 101 budget demands directing concerned ministries and departments in category B and category C to limit expenditures to 20% and 15% respectively in the first quarter. This does not seem like working.  

The government has lot of borrowings off-budget which distort deficits and financing thereof.  

In this concluding part III, I explore the issues connected with what is likely increase in fiscal deficit on account of rising expenditures and falling revenues and what is the best way to financing the same.

EXPENDITURES

April 8 Order Unlikely to Deliver Any Savings

Government has imposed a cut on expenditure by limiting expenditure of 31 category B ministries and departments to 20% and 52 category C ministries and departments to 15% of their respective annual budgets.

Budgeted expenditure of category A, B and C for 2020-21 is Rs. 14.38 lakh crore, Rs. 11.45 lakh crore and Rs. 5.01 lakh crore. If the category A ministries and departments incur expenditure @ of 30% as per trend and the rest of the ministries and departments limit it as per April 8 order, the April 8 order could have resulted in lesser expenditure of Rs. 1.90 lakh crore.

This, however, is unlikely to happen as explained comprehensively in Part I of this series of blogs. I therefore do not assume any saving of expenditure on account of this order.

Economic Packages Which India Needs

Over 70% of businesses lost their production of goods and services resulting into loss of income in the most stringent kind of lockdown enforced in India. This also rendered an estimated 10 crore workers out of jobs. This almost total lockdown is to last until 20^th April.

Gradual and cautious opening of economic activities post April 20 may cause lot of production losses to last for many more months- most certainly for the April-June quarter.

There are many businesses which may not come to normal even after economic activities are opened up fully. Threat of COVID-19 virus is likely to linger on for many years. This would make some businesses, especially on the service side- transportation of all types including buses, airlines, taxis etc., travel, hospitality etc. to suffer permanently.

It is difficult to quantify loss of GDP for FY 2020-21 at this stage. However, it appears fairly certain that about 50% of GDP for April and average of 25% GDP for May and June will be lost. This would mean that at least one month’s GDP for the year which is about 8-9% would definitely be lost. As India is growing at about 5% currently, it definitely means that India will face contraction in the year 2020-21. This might be of the order of 4-5%.

One will have to revisit this in July-August to take stock of the situation.

There is a chorus for stimulus package. I think we need three types of well-designed packages- survival, revival and stimulus- for addressing the economic havoc caused by COVID-19 and consequential lockdown.

The loss of so much of output and crores of jobs have led to three kinds of impacts on suffering households and businesses.

First, all the three types of poor- destitute, economically poor and vulnerable poor (these classes explained comprehensively in Part II of this series of blogs) have suffered and many have been reduced to the state of destitution. There is a need for a Survival Package for such people.

Second, there are over 8 crore businesses in India. Most, about 7 crores, are very small, often single person run, businesses. These are outside the reach of formal credit system as well. Most organised businesses, leaving aside small number of businesses, have also lost their sales making these unable to pay wages to their employees. These businesses would have to revive their businesses. They need a Revival Package.

Third, A few businesses have actually gained in this crisis. There are also a few other sectors which can probably increase their production and exports once the economic activities resume. India needs to take advantage of these opportunities. These might need a supply side Stimulus package. I don’t see feasibility of a demand side stimulus package in the current situation.

Survival Package

The government announced a 1.7 lakh crore relief package (Pradhan Mantri Garib Kalyan Yojana) on 26^th March. This provides relief to a considerable number of poor households. While not specifically addressed, this package provides relief to both the destitute and the economically poor.

Three crore non-working poor (aged, handicapped, widows etc.- destitute) gets Rs. 2500 in cash- a one-time benefit of Rs. 1000 and additional Rs. 500 per month in their Jan-Dhan accounts.  This is in addition to the normal pension and other benefits which these families get.

There were 25 crore households as per Socio Economic and Caste Census carried out in 2009. These households might have grown to about 30 crores by now. 26^th March Garib Kalyan Package attempted to address the needs of about 2/3^rd of these households.

Deposit of Rs. 500 per month for three months (Rs. 1500 per beneficiary) in the Jan-Dhan accounts of 20 crore women, delivery of three LPG cylinders free of cost to 8 crore Ujjwala households (worth about Rs. 2000 per beneficiary) and 5 kg of cereals and 1 kg of pulses per month to all the ration card holders free of cost (worth about Rs. 500 per family) would provide support of about Rs. 4000 to at least 8 crore families and Rs. 2000 to remaining approximately12 crore families.

Most of the 10 crores labour who have probably lost their jobs in this lockdown would likely be covered at least in the rupee 2000 benefit category. This support is quite certainly inadequate. However, the migrant labour is facing additional problem of not being able to access this on account of being locked down in places other than their villages.

It is time India builds a database of all its workers with information on their wages, status of employment and bank accounts. The government should have come up with a targeted survival package for this workforce. It is time that the government comes up with such a package.

A Rs. 2000 per month assistance to 10 crore of these workers for 3 months would cost Rs. 60000 crores. This survival package should be announced and implemented without loss of any more time. It is not difficult to register these workers very quickly and deliver this benefit.

Revival Package

An 8-9% loss of GDP translates into loss of about Rs. 16-18 lakh crore of output/income. The small and informal business in construction, manufacturing and services has lost their incomes disproportionately. These businesses would end up suffering losses of not less than 10 lakh crores.

There are large number of small businesses in the country- approximately about 7 crores. Disappearance of their income has made them lose their own and their workers’ livelihood. There liabilities for rent, service of loan instalments for assets and other expenditures, however, survive. These small businesses are probably sitting on losses of about Rs. 3-4 lakh crore.

These businesses require both grant and credit support for their revival. Credit for working capital and grant for meeting their wages, rent and other liabilities. The grant support can only be provided by the government. Even if the government were to cover 50% of the losses these small businesses are suffering, the fiscal assistance needed appears to demand about 1.5 lakh crore to 2 lakh crore of revival package.

It also appears quite necessary that the government comes up with this package to assist at least these small businesses. To make sure that this package is utilised essentially for payment of wages, including for the small business entrepreneur, the amount of assistance should be made conditional upon continuance of employment of workers and payment of lost wages assistance in their bank accounts. This package should be announced as soon as possible and implemented in the first quarter itself.

Additional Expenditure for Survival and Revival Packages

Pradhan Mantri Garib Kalyan Package is likely to cost Rs. 60,000-70000 crore in 2020-21 in additional expenditures over and above the budgeted.

The survival package is estimated to cost about Rs. 60000 crores.

The revival package should cost about 1.5 to 2 lakh crores.

Taking all these costs in consideration, the government may likely face an additional expenditure demand of about 3 lakh crores in the financial year 2020-21.

Bringing Off-budget Liabilities On-Budget

There are liabilities of Rs. 3.11 lakh crore (as explained in the Part I of this series of blog) which are off-budget for the year 2020-21. These should be brought on the budget to end this distortionary practice of keeping certain expenditures outside the budget.

REVENUE SHORTFALL

Government tax and non-tax revenues are going to suffer as well.

April-May are weak months for tax revenues. Central government gets about 4.5% of its net tax revenue in April and a little less than 7% in the first two months of April-May. Centre’s budgeted net tax receipts for 2020-21 are Rs. 16.36 lakh crores. Going by the past performance, the centre should receive, in normal course, approximately Rs. 75000 crores of tax revenues by April and Rs. 1.25 lakh crores by May end. There is a 25%-75% split between personal income tax (hardly any corporate tax revenue comes in first two months) and indirect taxes (central GST, customs and excise put together).

Loss of output and imports directly affects government’s indirect tax collections- GST, Excise Duties and Customs Duty. Loss of corporate profits will impact Corporate Tax revenues. There would also be impact on salaries income affecting personal income taxes.

Indirect Taxes

The indirect tax paying industries and services are massively shuttered in the current COVID-19 forced lockdown. Petroleum products demand is reportedly down by 66%. Ports are not operating. Most of the manufacturing and construction is shut.

The indirect tax collections in April-May are likely to be down by not less than 60%. The weakness will persist for many months.

The industrial activities, imports and consumption of petroleum products are unlikely to revert to the normal anytime soon. Rather, there might be permanent impairment to many producers. It also depends upon the pace at which COVID-19 gets contained and the government allows normalisation of economic activities.

Indirect taxes (most particularly GST) are a play on the GDP, more particularly GDP coming from large corporate sector and service sector. Excise duties are dependent upon volume of diesel and petrol sold and the rate of excise duties. These taxes are budgeted to deliver about 11 crores on gross basis and 7.5 lakh crore on net basis.

It seems about 15% of GST paying GDP will suffer this year on account of lockdown of about 70% such economy in April and graded recovery over the rest of year. This might lead to a loss of GST tax revenue of about Rs. 1 lakh crore.

Crude prices have crashed. These are likely to remain significantly lower than last year’s average prices. The government has raised excise duties by Rs. 3 each on diesel and petrol. The government has also assumed powers to increase these duties further.

Volume loss in April so far has been ferocious- down by over 60% on diesel and 80% on petrol. Aviation fuel sale has virtually come to less than 10%. It will be no surprise if for the year as a whole, the petroleum products witness volume loss of about 25%. There may be loss of about Rs. 30,000 crores on excise duties and another Rs. 20000 crores on customs duties.

While it is early to assess the full year impact, considering the broad factors- not less than 10% annual GDP loss in first quarter, substantial reduction in consumption of petroleum products and massive shut down of imports, it is fair to estimate that the loss of indirect taxes will not be less than 1.5 lakh crore.

Direct Taxes

Corporate tax revenue is heavily dependent on corporate profits. Large profit making and corporate tax paying entities in automobile, petroleum and gas, financial sector, refineries, cement etc. are likely to suffer big dent in their profitability. It may not be surprising if the corporate taxes suffer reduction in their profits by about 20%-25% this year.

In the context of budgeted corporate tax revenues of Rs. 6.81 lakh crore, this would mean a loss of about Rs. 1.7 lakh crore of revenues. On net to centre, this will mean another Rs. 1.2 lakh crore of revenue loss.

Personal income taxes are a proxy on the salaries of workers in the organised sector. There would be impact on bonuses, leave travel concession, grant of pay rises and, in a few cases, reduction in salaries etc.

I would assume a loss of about 10% or about Rs. 60000 crores of lesser revenues in personal income tax.

Shortfall in direct tax revenues is thus estimated at about 1.5-1.8 lakh crore.   

Disinvestment receipts and non-tax revenues

Non-tax revenues were projected at Rs. 3.85 lakh crores and disinvestment revenues were expected to be Rs. 2.10 lakh crores.

Disinvestment programme is effectively grounded. As explained in Part II, the government would have to revisit its disinvestment strategy completely. Dividend yielding oil, coal, metal and power sector companies are unlikely to generate profits of last year. There would be shortfall in dividends and profits.

With disinvestment programme suffering a long period of inactivity and under performance in non-tax incomes, it is quite likely that there would be substantial short fall on non-tax receipts. It might be of the order of about Rs. 2 lakh crores.

Revenue receipts under performance

Taking impact on direct taxes, indirect taxes, non-tax revenues in consideration, it seems that the government is facing shortfall of not less than Rs. 5 lakh crores.

FINANCING ADDITIONAL FISCAL DEFICIT

What is Additional Extraordinary Financing Requirement?

Government’s fiscal expenditures are likely to go up by another Rs. 3.0 lakh crore, over and above the budgeted expenditure of Rs. 30.42 lakh crore in the financial year 2020-21.

The government should bring off-budget expenditure of Rs. 3.11 lakh crore on-budget.

Therefore, on expenditure side, there is likely to be a need of additional financing of Rs. 6 lakh crores.

The revenue side is likely to see shortfall of another Rs. 5 lakh crores. Tax revenues may decline by about Rs. 3 lakh crores. The disinvestment and non-tax receipts may fall by about Rs. 2 lakh crores.

The government may, therefore, have to resort to additional fiscal deficit financing of Rs. 10-11 lakh crore.

Options for Financing Fiscal Deficit

There are three principal options to fund this extra-ordinary requirement of deficit financing.

First, the government may turn to the households, appealing to their hearts, and call upon them to turn-over their savings to the government in this big hour of fiscal distress. The government had on some earlier occasions, like the 1965 and 1971 wars, appealed to the citizens to buy defence bonds and contribute their savings in similar structures.

Second, the government reach out to the credit markets (banks, insurance companies, retirement funds like EFPO, mutual funds and foreign portfolio funds) to take up additional borrowings.

Third, the government relies upon the central bank, the RBI, to fund this extra-ordinary requirement as a special case.

There have also been some suggestions to issue COVID bonds.

Appealing to Savers Offers Limited Scope

Financial savings of households are only about 8% of GDP. Most of these financial savings, in any case, are invested in government. Savings of about 1-1.5% of GDP come directly to the government in small savings accounts and provident fund accounts of government servants.

Households savings are also parked in provident fund accounts with EPFO, pension fund accounts in NPS, deposits with banks and in other financial products with insurance companies and mutual funds.

All these institutions end up taking up a lot of government securities. As general government’s fiscal deficits (state governments included) are about 8%, including off-budget, almost all the household savings effectively are invested with the government.

People are contributing to PM CARES, CM Relief Funds and many other initiatives answering to the emotional calls.

The suggestion of issuing special COVID-19 bonds refers to two types of such special bonds. First, normal bonds specially designated to appeal to the emotions and second, catastrophe bonds.

It is unlikely that, given these factors, there would be much special interest in subscribing to any class of bonds, which are otherwise normal, but only specially designated. If issued, it might yield paltry amount not exceeding 20-25000 crore.

The CATASTROPHE or CAT Bonds are issued in normal times offering a little higher rate of interest but repayment of principal conditional upon the related catastrophe not materialising. You cannot issue such bonds when the catastrophe has already stuck.

Extra Load on Credit Markets

Banks, insurance companies, mutual funds, retirement funds like EPFO etc. and the foreign institutional investors (FIIs) are the principal takers of the government bonds. Banks hold about 40% of the central government bonds. RBI holds around 10-15% of bonds. Insurance companies hold about 20-25%. Rest of the players in the financial markets, including FIIs holds the remaining stock.

Banks are holding more than what they are statutorily required to hold. Banks are also primarily meant to lend to the real sector companies and other non-bank companies to provide much needed credit for the markets.

Loading this extra-ordinary supply to the banks would be counterproductive. The banks would be happy parking their liquidity with the government which does not expose them to any risk. The economy would, however, lose. Efforts for reviving the affected businesses would further suffer.

The non-bank financial institutions are also seeing their cash flows suffer in this lockdown. FIIs sold over Rs. 50000 crores of bonds in March.

It would be very unrealistic to expect the financial market participants to absorb even a quarter of additional government borrowing of Rs. 10 lakh crores.

Monetisation of Deficit- Right Solution in the Circumstances

Covid-19 is a global epidemic. It has caused unprecedented health crisis and economic disruption. The additional fiscal deficit requirement of about Rs. 10 lakh crores is truly extraordinary.

The savers cannot take this up. Asking banks and other financial institutions to provide financing would roil the credit markets. The real economy will get starved of credit, which is much more needed in these disruptive times.

RBI has provided direct subscription to GOI bonds earlier. I have dealt with the issue of how amendment of FRBM law would allow the RBI to meet this extraordinary requirement.

It is advisable that the RBI subscribes to these bonds directly. Subscribing indirectly i.e. RBI buying virtually equal amount of bonds from the secondary market to create space for these institutions to subscribe to new government bonds means the same thing effectively. 

CONCLUSION

Government of India’s attempt to secure some savings (April 8 Order) from the budgeted expenditure are unlikely to yield any meaningful savings.

There is a requirement of a Survival Package for sustaining the lives of over 10 crore workers who have been rendered jobless. Inclusive of the elements of PM Garib Kalyan Package announced on 16^th March which address the needs of these workers, the Survival Package will cost the government about Rs. 1.5 lakh crore.

A Revival Package for putting the small and informal business back on their feet is also needed. This package aimed at covering a part of the wages of the workers (including the owner of self-employed businesses) and supporting these businesses to cover the unavoidable expenses like rents, payment of interest instalments, maintenance for the time of lockdown will cost about Rs. 1.5 lakh crore.

It is also right time to bring off-budget borrowings of about 3 lakh crores on the budget now to clean up the expenditure financing and borrowing system.

In all, the additional borrowing requirement on the expenditure side is Rs. 5-6 lakh crore.

All taxation revenues are also likely to suffer.

Indirect taxes, GST, Excise Duty on petroleum products and Customs will underperform. While estimate shortfall for the entire year is impossible at this time, the likely loss of GDP, sale of petroleum products and lesser imports in first three months (April-June) suggest that there will be shortfall of indirect tax revenues by Rs. 1.5 lakh crore.

Corporate taxes are also going to suffer even if we assume reduction in corporate profits by only 15-20%. It might be much more. Likewise, personal income taxes would also receive some beating on account of loss of income and bonuses etc. I have estimated shortfall on account of corporate taxes and personal income taxes to be, at the minimum, Rs. 1.5-1.8 lakh crore.

Disinvestment programme is likely to remain grounded for quite sometime resulting into substantial under performance. Likewise, there would be definite shortfall in dividend and profits non-tax income. On both these accounts, there might be short fall of about Rs. 2 lakh crores.

It would be advisable to proceed on managing the budget financing taking into consideration likely shortfall of Rs. 5-6 lakh crore on tax and non-tax revenue front.

Taking all these together, there is likely to be an additional shortfall of not less than Rs. 10 lakh crores in the financial year 2020-21.

The options of resorting to household savings or issuing any special bonds like COVID bonds are unlikely to be of much help. Forcing this additional borrowing requirement on banks and other financial institutions is likely to be more counter-productive. It would dry up the credit to real businesses further during these tough times when there is need for the credit to reach these businesses.

The only feasible and the least disruptive measure is to monetise this additional deficit and the RBI to meet this financing requirement.

SUBHASH CHANDRA GARG

NEW DELHI 16/04/2020