Impact of Covid-19 on Government Finances

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    The government released the First Advance Estimates (FAE) at the start of January 2021 and the Second Advance Estimates (SAE) in February 2021, which showed the impact of Covid-19 on the finances of the Centre and the States in 2020.

    Key Highlights

    • First Advance Estimates
      • The Gross Domestic Product (GDP) would contract by 7.7 per cent in Fiscal Year (FY) 21.
      • The Gross Value Added (GVA) would contract by 7.2 per cent.
        • GVA captures the value added (in money terms) by economic agents in each sector of the economy.
        • The GDP is arrived at by taking the GVA number, adding all the taxes earned by the government and subtracting all the subsidies provided by the government.
      • India’s per capita GDP, per capita private consumption and the level of investments in the economy, all were expected to fall to levels similar to those of 2016-17 or earlier.
    • Second Advance Estimates
      • Showed that the contraction in GDP would be 8 per cent instead of 7.7 per cent.
      • GVA would contract by only 6.5 per cent and the growth rate of GVA was expected to get better.
        • The change between FAE and SAE might be marginal but the turnaround in GVA suggested a recovery in the Indian economy.
    • Provisional Estimates
      • Since February-end, India has been witnessing the second wave of Covid-19 and the impact on the economy would be estimated in the Provisional Estimates (PEs) for the full financial year 2020-21, to be released by May-end.
      • The data would also provide the new benchmark for assessing economic growth for the current financial year (FY22).
    • India’s GDP growth rate in the current financial year (2021-22 or FY22) is forecasted to be 9.7 per cent.
      • According to an International Monetary Fund (IMF) analysis, if one presumes a contraction of 8 per cent in FY21 then a GDP growth of 9.7 per cent in FY22 is just a statistical phenomenon.

    Impact on Centre’s Finances

    • Revenues, both from tax and non-tax sources, fell sharply and the government overshot its expenditure as well.
    • This resulted in the Union government’s revenue deficit (the difference between its revenue receipts and its revenue expenditure) as well as its fiscal deficit (a measure of its overall borrowing) rising sharply.
      • In its original intent, the Fiscal Responsibility and Budget Management (FRBM) Act, 2003expected the revenue deficit to be zero and the fiscal deficit to be limited to 3 per cent.
      • While the central government has been failing to meet either of these targets for over a decade yet, the Covid disruption has meant that the government’s fiscal deficit will remain out of shape for a while.

     

    • 61 per cent of the rise in fiscal deficit was due to a fall in revenue and 39 per cent was due to a rise in expenditure.
    • The table shows that all tax and non-tax revenues took the biggest hit except for Union Excise Duties (UEDs):

    • However, the massive jump in UED collection did not benefit the states since the Union government collected it by increasing cesses and surcharges on UED instead of raising the basic UED rate.
      • Cesses accounted for 65 per cent of all the UED collection in FY21, registering an annual growth of 187 per cent.
      • In fact, if one removed the cesses and surcharges, the UED collections for the past financial year would actually fall by 20 per cent, instead of going up by 50 per cent.
      • The proceeds of cesses and surcharges are not shareable with states.

    Impact on States’ Finances

    • To analyse the situation for states, the monthly statements of accounts (Monthly Key Indicators) data provided by the Comptroller and Auditor General (CAG) of India were used.
      • The data was taken for 16 major Indian states (excluding Goa and Bihar) till December 2020, i.e., up to the third quarter (Q3) of 2020-21.
    • The main takeaway was that, on the aggregate, states have contained their revenue as well as capital expenditures to cope up with the revenue shock.
    • However, the containment of expenditures was not sufficient to compensate for the contraction in total receipts.
    • Consequently, in the first three quarters of FY21, these states saw their revenue deficits exceed the budget target by almost 240 per cent and their fiscal deficit by over 40 per cent.
    • State-level finances are not as badly hit as the Centre and this has happened despite the fall in Union taxes resulting in lower tax devolution to states by 30 per cent.
    • Around half of all state-level tax revenues come from ‘Own Tax Revenues’, which include taxes such as state GST, state sales tax, state excise duties, stamps and registration fees, land revenues, etc.
    • The table shows statewide variations, both in terms of revenues raised and expenditures made:

    International Monetary Fund

    • It was established in 1944 in the aftermath of the Great Depression of the 1930s.
    • IMF and the World Bank are also known as the Bretton Woods twins because both were agreed to be set up at a conference in Bretton Woods in the US.
    • It is governed by and accountable to the 190 countries that make up its near-global membership.
      • India became a member in December 1945.
    • Aim: To ensure the stability of the international monetary system (the system of exchange rates and international payments) which enables countries and their citizens) to transact with each other.
      • Its mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear on global stability.
    • Financing: The IMF’s resources mainly come from the money that countries pay as their capital subscription (quotas) when they become members.
      • Each member of the IMF is assigned a quota, based broadly on its relative position in the world economy.
      • Countries can then borrow from this pool when they fall into financial difficulty.
    • Publications
      • World Economic Outlook
      • Global Financial Stability Report
      • Fiscal Monitor
      • Global Policy Agenda

    (Image Courtesy: IMF)

    Fiscal Responsibility and Budget Management Act, 2003

    • It establishes financial discipline to reduce the fiscal deficit.
    • It was introduced in 2000 and was approved by the Union Cabinet in 2003 and became effective from 5th July 2004.
    • Aims
      • To introduce transparency in India’s fiscal management systems.
      • To achieve fiscal stability and to give the Reserve Bank of India (RBI) flexibility to deal with inflation in India.
      • To introduce more equitable distribution of India’s debt over the years.
    • Key Features
      • It made it mandatory for the government to place the following along with the Union Budget documents in Parliament annually:
        • Medium Term Fiscal Policy Statement
        • Macroeconomic Framework Statement
        • Fiscal Policy Strategy Statement
      • It proposed that revenue deficit, fiscal deficit, tax revenue and the total outstanding liabilities be projected as a percentage of GDP in the medium-term fiscal policy statement.
    • Exemptions: On grounds of national security, calamity, etc, the set targets of fiscal deficits and revenue could be exceeded.
    • In 2013, the government introduced a change and introduced the concept of effective revenue deficit.
      • This implies that effective revenue deficit would be equal to revenue deficit minus grants to states for the creation of capital assets.
    • In 2016, a committee under N K Singh was set up to suggest changes to the Act and its recommendations are as follows
      • Targets: The committee suggested using debt as the primary target for fiscal policy and that the target must be achieved by 2023.
      • Fiscal Council: It proposed to create an autonomous Fiscal Council with a chairperson and two members appointed by the Centre (not employees of the government at the time of appointment)
      • Deviations: The committee suggested that the grounds for the government to deviate from the FRBM Act targets should be clearly specified.
      • Borrowings: According to the suggestions of the committee, the government must not borrow from the RBI, except when
        • The Centre has to meet a temporary shortfall in receipts.
        • RBI subscribes to government securities to finance any deviations.
        • RBI purchases government securities from the secondary market.

    Comptroller and Auditor General

    • The Constitution of India provides for an independent office of the Comptroller and Auditor General of India (CAG).
    • He/she is the head of the Indian Audit and Accounts Department and is the guardian of the public purse and controls the entire financial system of the country at both the levels, the Centre and the States.
    • It is his/her duty to uphold the Constitution of India and the laws of Parliament in the field of financial administration.
    • Evolution
      • The idea of CAG evolved in British India. In May 1858, for the first time, a separate department was set up with an Accountant General, who was responsible for accounting and auditing the financial transactions under the East India Company (EIC).
      • In the Montford Reforms of 1919, the Auditor General became independent of the government.
      • The Government of India Act 1935 strengthened the position of the Auditor General by providing for Provincial Auditors General in a federal set-up.
    • Constitutional Provisions for CAG
      • Article 148: Appointment, oath and conditions of service.
      • Article 149: Duties and powers.
      • Article 150: The accounts of the Union and of the States shall be kept in such form as the President may, on the advice of the CAG, prescribe.
      • Article 151: Deals with the Audit Reports.
        • The reports of the CAG relating to the accounts of the Union shall be submitted to the president, who shall cause them to be laid before each House of Parliament.
      • Article 279: Mentions that calculation of “net proceeds” is ascertained and certified by the CAG, whose certificate is final.
      • Third Schedule: Section IV of the Third Schedule of the Constitution of India prescribes the form of oath or affirmation to be made by the Judges of the Supreme Court (SC) and the CAG at the time of assumption of office.

    Source: IE