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January 27, 2020

Indian Economy: Defiant deficit

India’s growth slowdown has put the best-laid plans of both the Centre and states into the wringer. A sharp growth slowdown in the current fiscal has resulted in tax shortfall and crimped the ability of the central and state governments to spend their way out of the current slowdown.


Our analysis of the evolving dynamics of rising fiscal stress of states and its implications for the spending patterns and means of financing the deficits, revealed the following: 


  • Fiscal deficit and liabilities of states as a percentage of gross domestic product (GDP) have been rising, and there is increased risk of breach in the budget estimate of fiscal deficit of 2.6% of GDP this fiscal
  • Contingent liability burden is higher in fiscally stressed states
  • Fiscal stress was due to a surge in revenue expenditure in fiscal 2019; this fiscal, it would likely be due to revenue shortfall
  • All this has worsened the quality of expenditure, and state-level data for April-November 2019 shows a drop in capital expenditure

Revenue shortfall of states and lower receipts from the Centre (due to its own poor collections) are pushing states to borrow more, at higher cost, and forcing them to trim essential capex. That’s not great news because states contribute to nearly two-thirds of the total public capex (Centre and states together) at the moment, and capex is what would eventually makes the wheels of the economy spin again.


A pull back on the part of states at a time when slowdown begs stimulus of any kind, would make the climb out of it that much harder to negotiate. Fiscal prudence is, therefore, a big concern for both central and state governments. Consequently, fiscal flexibility to stimulate the economy is low due to pre-defined deficit targets.


A much needed fiscal stimulus would entail a transient deviation from the fiscal glide path, and can also come from fast-tracking of divestments and large-scale asset monetization. The government should do both to support growth.


Corporation tax cut and other moves, medium-term positives for growth, are unlikely to help in the near term. At the same time, some fiscal relaxation is unlikely to lead to demand-led inflation, as we foresee the economy staying below potential in the coming fiscal even with fiscal stimulus.