Economic Situation

Context: Global growth prospects for 2020 have been projected by a number of multilateral institutions and rating agencies including that for India.

Real GDP Growth Numbers

Pandemic Devastated Growth: India’s growth in the first quarter of 2020-21 at (-) 23.9% showed one of the highest contractions globally
Real GDP Growth Projection: Reserve Bank of India’s Survey of Professional Forecasters estimate 2020-21 real GDP growth for India in the range of -5.8% to whereas Goldman Sachs projects it as -14.8%.
OECD in its September 2020 Interim Economic Outlook has projected a contraction of -10.2% in FY21 for India

Inflation Projection for this Fiscal

The latest data released by the Ministry of Statistics indicate a Consumer Price Index (CPI) inflation rate of 6.7% for August 2020.
The average CPI inflation during the first five months of 2020-21 is estimated at 6.6%.
Given the injection of periodic liquidity into the system and the inflation trends, the year as a whole may show a CPI inflation of close to 7%.
Since deflator-based inflation tends to be lower than the CPI inflation, it may be about 5% or less.

Are there sectors which hold hope for growth revival?

There was hope that some key sectors such as agriculture and related sectors, public administration, defence services and other services may perform normally or better than normal given the demand for health, relief and revival expenditures
However, the recently released national income figures for Quarter I of 2020-21 hold no such hope
The most surprising in the Q1 data is that the sector ‘Public Administration, Defence and other Services’ contracted at (-) 10.3%. This means that there was no fiscal stimulus.
Independent estimates show that States’ capital spending fell by 43.5%.
The worsening of the fiscal deficit appears to be because of decline in revenue than increase in expenditure

Revenue Erosion

In the first quarter of 2020-21, the Centre’s gross tax revenues contracted by (-) 32.6% and the CAG-based data pertaining to 19 States show a contraction of (-) 45% in their own tax revenues.
The revenue calculations of the Budget were made on the assumption that the nominal income of the country would grow at 10%.
With the prospect of a contraction even in nominal growth (-5%), tax revenues of the Centre would show a considerable shortfall as compared to the budgeted amounts.
Some estimates indicate that the tax and non-tax revenue and non-debt capital receipts in the current fiscal may fall well short of the budget estimates by an amount higher than ₹5-lakh crore
Only way out: The combined fiscal deficit of the Centre and the States will have to make up for the shortfall in tax and non-tax revenues, if the level of budgeted expenditures is to be maintained.

Fiscal Deficit

In order for the central government to maintain the level of budgeted expenditure and also provide for additional stimulus, its fiscal deficit may have to be increased to close to an estimated 8.8% of GDP.
If one adds the Centre’s and States’ fiscal deficit, the combined fiscal deficit amounts to 13.8% of GDP.
It may be noted that the Centre’s fiscal deficit to GDP ratio for the Q1 of 2021 was 17.4%. The Centre’s fiscal during the first four months of 2020-21 as a per cent of annual budgeted target was at 103.1%.

How to fund the high fiscal deficit?

There are not adequate resources to support a fiscal deficit of nearly 14% of GDP.
All this will therefore require substantial support from the RBI which will have to take on itself, either directly or indirectly, a part of the central government debt
In the direct mode, the RBI takes on the debt directly from government at an agreed rate.
In indirect mode the RBI would operate only in the secondary market through the OMO (open market operations) route. OMOs involve the sale and purchase of government securities to and from the secondary market by the RBI to adjust the rupee liquidity conditions
Both direct monetisation of debt and OMOs involve expansion of money supply that can potentially result in inflation.

Conclusion

The economic situation warrants enhanced government expenditure; the policy challenge is to minimise the growth fall

Connecting the dots:

Balance of Payment Crisis of 1991
2008 Global Financial Crisis

Economic Situation