State of Public Finance in India during COVID-19

The novel coronavirus pandemic has cast a long shadow of financial uncertainty for both the Centre and states. The impact of the pandemic on the economy and the lives of the economically and socially disadvantaged requires a sizeable government funding exercise to try and limit the ripple effects of the pandemic. Livelihoods need to be supported, funding requirements closed, and the economy be given a financial helpline. Thus, the act of financing said requirements, given finite resources, is of the utmost importance. This, however, is extremely challenging given the tools at the disposal of the authorities tasked with mitigating the deleterious effects of COVID-19 – the state governments.

A glance at the macroeconomic indicators

To begin with, finances at the Centre are under severe duress, and this was the case even before the COVID-19 pandemic struck. As per Nirmala Sitharaman’s budget speech in February of this year, national economic growth for the financial year (FY) 2020-21 was forecasted to grow at a nominal rate of 10%.1 Even though growth figures for the entire FY of 2019-20 are yet to be released, the dismal reading of growth registered in the year’s third quarter, that of a seven year low 4.7%, does not spell good reading for the entire year, let alone a financial year-end ravaged by a pandemic.2 Add to that over-optimistic tax collection forecasts, with a 33% increase in both direct and indirect tax mop up required in the current FY in order to meet budgeted tax revenue predictions, off the back of grossly overestimated forecasts laid out in the revised edition of last year’s budget.3 With direct tax collection contracting 5.4%, despite net receipts rising due to a substantial fall in the refunds paid out, in the first month of this FY, actual tax collection for the entire year does not appear to be ending up anywhere close to the forecasts.4 If anything, the announcements made by the FM regarding Atmanirbhar Bharat Abhiyan demonstrates the extremely precarious fiscal position of the Centre given the relatively small amounts of fiscal outlay it would require compared to the overall quantum of the economic stimulus measure which is Rs. 20 lakh crore.

The Centre’s largest sources of revenue are corporation tax, income tax, the Goods and Services Tax (GST) and gross market loans, as per the last two budgets.5, 6 The next biggest contributors to the Centre’s coffers, non-tax revenue and excise duties, is half of any one of these four. With the government reducing effective corporation tax rates to 25.17% from 35%, and with GST and income tax gross collections put under severe pressure from the drastic fall in economic activity as a result of the lockdown, revenues collected by the Centre are sure to take a considerable hit.7 Therefore, the only avenue that can propel greater government expenditure towards efforts to revive the economy is gross market borrowings. Fiscal Responsibility and Budget Management (FRBM) fiscal deficit limitations, even beyond the current invoking of the exception clause that mandates a 3.8% adherence level for the current FY, would have to be further relaxed by the Finance Commission as a result. India’s sovereign external debt to GDP ratio is one of the lowest of the world at 5%. 8 Although the country’s fiscal deficit, when taking into consideration all levels of government, is 7.5% as per the International Monetary Fund (IMF), an emerging market high, and reservations abound with regards to external sources of debt, authorities might be left with no choice but to keep aside fiscal prudence for the time being in order to construct an able economic recovery. 9

Coming to the states and their finances, as per a Reserve Bank of India(RBI) report on the status of state finances, nearly half (45%) of states’ revenues come from their own taxes while 47.5% arrive via the Centre and its transfers. 10 Out of the revenue collected by the state through its own taxes, 90% comes from just four avenues – taxes collected through the sale of liquor, petroleum products, stamp duty and registration of vehicles. With automobile heavyweights such as Maruti Suzuki and Hyundai announcing no domestic vehicle sales in the month of April, flights and cars parked idle, and property registrations taking a hit due to falling real estate sales, it is no wonder states welcomed news of liquor shops being allowed to function during the latest variant of the lockdown that began on May 4. According to the State Bank of India’s  Ecowrap research publication, combined fiscal deficit of 19 states could rise to 3.5% of GDP in FY2021 from the budgeted 2.04%. 11 Further, a collection of states has called for easing of FRBM fiscal deficit and borrowing limits, besides a frontloading of this market-led borrowing. 12 With allocations under the State Disaster Risk Management Fund being called into question, GST dues to the tune of 40,000 crore yet to be received, revenue deficit grants, as recommended by the 15th Finance Commission, falling short by another 44,000 crore and the suspension of Members of Parliament Local Area Development Scheme, states are extremely restricted when it comes to their potential financing options. 13

The COVID-19 relief package

Union finance minister announced a COVID-19 relief package on March 26 that incorporated cash transfers to senior citizens, women, widows, differently abled, and farmers, the distribution and disbursement of ration, gas cylinders, loans to self-help groups and higher Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) wages, as also PF withdrawals. 14 Till April 14, the government had released just under 50% of the promised cash amount as also the food grains and cooking gas cylinders, as per a statement put out by the ministry of finance. 15 However, with stories of migrant workers trudging along highways on their way home, many not able to make it, home shelters in dilapidated conditions, food not making its way to these persons, as attested to by surveys, disinfectants being sprayed on them by police and the Aurangabad train incident, amongst other atrocities, the relief package and responses to countering the spread of the COVID-19 virus does not do enough for those most socio-economically disadvantaged. 16 Further, with the country’s relief package, including the recently announced Atmanirbhar Bharat Abhiyan, at 10% of GDP, compared to Malaysia (16.2%), Singapore (12.2%), Japan (20%), and the UK (17% as on April 13), there have been vociferous calls for a sizeable increase in the country’s subsequent relief packages, should they arrive. 17, 18 The economic aid must also be utilised to prop up demand and income, instead of the liquidity relief that has been announced by Nirmala Sitharaman over past week. With systemic changes such as the amendment to the Essential Commodities Act and agricultural marketing reforms potentially being met with bureaucratic red-tapism, and with no additional income support to be given, coupled with the absenteeism of those most marginalized from the formal credit system, India’s economic stimulus does not provide immediate relief to those most affected by the country’s stringent lockdown.

What about the unutilised funds?

In the build-up to announcing the March relief package, the Union finance minister had also announced that states should utilise District Mineral Foundation (DMF) funds and cess funds created for the welfare of construction workers for COVID-19 response preparedness and welfare service delivery for that category of workers, respectively. With the utilisation pattern of the construction workers’ cess funds highlighting not only dormant usage but also excessive capacity, pressure needs to be applied on states to use these resources for the betterment of their citizens. 19 DMF are non-profit trusts set up by the Mines and Minerals (Development and Regulation) Amendment Act, 2015. They were established with the objective to work for the benefit and interest of people and areas affected by mining-related operations. Besides there being doubts about the utilisation of these funds, problems of oversight and monitoring of the funds earmarked for welfare purposes persist. 20 Further, there are doubts about utilising resources that cater to at-risk populations, like the indigenous tribal groups, for dealing with an emergency crisis. It might set similar precedents for future events wherein resources that have been targeted at specific populations get exhausted even before other means are explored.

A similar question can be raised against the suspension of the Member of Parliament Local Area Development Scheme and its funds being repatriated to the Consolidated Fund of India under the Centre. This, even as the main relief fund set up by PM Modi, the Prime Minister Citizen Assistance and Relief in Emergency Situations (PM CARES), continues to collect donations such as the railways’ recent rupees 151 crore pledge while lacking on transparency and accountability.21 The fund could also divert resources away from other non-profits and localised solutions since donating to it is recognised as CSR contributions, besides it completely sidestepping the existence of the Prime Minister’s National Relief Fund that has been in existence since 1948 for the very same national disaster management purposes. 22

RBI’s measures

The RBI has, so far, announced additional liquidity measures such as lowering of the cash reserve and liquidity coverage ratio, policy repo and reverse repo rate, targetted long-term lending directed at priority sector funding houses such as mid- to low-tier non-banking finance companies, Small Industries Development Bank of India, National Bank for Agriculture and Rural Development and National Housing Bank, and money injection exercises like the provision of 1- to 3-year bonds. 23 However, doubts remain as to the risk coverage and high credit spreads of these instruments. Without the government taking over risk management for financial institutions, like the federal government in the US providing credit guarantees to lenders, targetted long-term lending instruments such as targetted long-term repo operations of the RBI’s will continue being under-subscribed, even with the regulatory forbearance in asset classification the central bank has announced. 24

With transmission of lower interest rates to lenders and the uptick in demand for these loans issues, the Central government might just have to borrow more, as described above. Although its external sovereign debt is relatively low as a percentage to GDP, risk aversion and capital outflow from emerging economies in emergency situations put such debt at increased risk. The nation’s foreign exchange reserve kitty of $476 billion can also be put to the test but an already sizeable current account deficit and high public debt financing issues, in light of the expected widening of the fiscal deficit, restricts the extent to which it can be harnessed. 25 Finally, there have been calls to monetise the fiscal deficit through the printing of fiat currency by the RBI. Even though inflation risks persist, March’s inflation numbers were the lowest in four months. 26 Plus, with the economy requiring a massive, but temporary, sustenance boost, even if inflation were to get pushed up in the near-term, it should fall back within the central bank’s preferred 2-6% range in the medium- to long-term. Emergency situations call for new inflationary frameworks. All eyes will be on RBI’s annual household inflation expectation survey to be released this month.

Budget rationalisation

Lastly, another potential source of financing could be the redrawing of the budget. Measures are already in place to bracket all COVID-19 related expenditure in a separate bucket in order to prevent budget constraints coming in the way of necessary revival-focused expenditure. 27 A shift in current allocations of budgets and the revenue and grant structure of states could also be implemented. At present, for example, the ministry of health has been accorded a paltry sum of 41% of the ministry of home affair’s FY2021 rupees 1.67 lakh crore budget. 28 Also, further non-essential and wasteful expenditure such as that carried out on the central vista redevelopment project (rupees 20,000 crore), and non-merit subsidies like food, fertiliser and petroleum, besides the examples mentioned previously, seemingly make room for significant financial priority reallocations. States, too, spend a great majority of their pools of financial resources on non-merit subsidies and goods. Some of them spend as much as 80% of their health budgets on salaries. 29 It has also been estimated that a rationalisation of non-merit subsidies of states can lead to the freeing up of fiscal space equivalent to 6% of GDP. 30 However, even the outlay on merit subsidies or public goods by states is hamstrung by the current fiscal architecture. The primary source of money for said expenditure is through central transfers to states through centrally sponsored schemes and central sector schemes. 31 This arrangement hampers and restricts not only the financial autonomy of states but also decision-making independence as central schemes (such as Integrated Child Development Scheme and National Health Mission) are the main modes through which state public good expenditure is done. The line ministries responsible for each of these schemes are too many and coordination amongst them is tempered by bureaucracy and red tape.

Conclusion

Wasteful and unnecessary expenditure needs to be tapered. States require a significant overhaul of their fiscal framework. The Centre needs to obey their end of the federal bargain. Fiscal and monetary policies seem to be too risky but emergency situations call for relaxation of otherwise prudential constraints. Without these measures in place, it is no wonder states like Maharashtra and Delhi have resorted to severe budget cuts, halting of any new project, and hikes in excise duties on petrol and diesel as also taxes on liquor, respectively.32, 33 In order to respond adequately to the next crisis therefore, fungible, flexible, autonomous and sustainable financing is of the utmost significance.

REFERENCES


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[2] Waghmare, Abhishek. 2020. “GDP Growth Slows to Nearly 7-Year Low of 4.7% in Q3 on Weak Manufacturing.” Business Standard. Business-Standard. February 28, 2020. Accessed May 4, 2020. https://www.business-standard.com/article/economy-policy/gdp-growth-slows-to-nearly-7-year-low-of-4-7-in-q3-on-weak-manufacturing-120022801654_1.html.

[3] Rao, Govinda. 2020. “Financing The Covid-19 Response: Challenges And Choices.” BloombergQuint. Bloomberg Quint. April 27, 2020. Accessed May 4, 2020. https://www.bloombergquint.com/coronavirus-outbreak/financing-the-covid-19-response-challenges-and-choices.

[4] Seth, Dilasha. 2020. “Refunds Save the Day for April Direct Tax Collection; Mop-up down 5%.” Business Standard. Business-Standard. May 2, 2020. Accessed May 4, 2020. https://www.business-standard.com/article/economy-policy/refunds-save-the-day-for-april-direct-tax-collection-mop-up-down-5-120050300014_1.html.

[5] Mazumdar, Ronojoy. 2019. “Budget 2019: What Is India’s Biggest Revenue Source.” Livemint. July 8, 2019. Accessed May 4, 2020. https://www.livemint.com/budget/news/budget-2019-what-is-india-s-biggest-revenue-source-1562554222302.html.

[6] India Budget. Accessed May 4, 2020. https://www.indiabudget.gov.in/doc/rec/ar.pdf.

[7] Dave, Sachin, and Vishal Dutta. 2019. “MAT Treatment Splits India Inc after Tax Cuts.” The Economic Times. Economic Times. September 28, 2019. Accessed May 4, 2020. https://economictimes.indiatimes.com/news/economy/policy/mat-treatment-splits-india-inc-after-tax-cuts/articleshow/71346691.cms?from=mdr.

[8] Press Trust of India. 2019. “Govt to Start Raising Part of Its Gross Borrowings from External Markets: FM.” Business Standard. Business-Standard. July 5, 2019. Accessed May 4, 2020. https://www.business-standard.com/article/pti-stories/govt-to-start-raising-part-of-its-gross-borrowings-from-external-markets-fm-119070500713_1.html.

[9] Bhatia, Surbhi. 2020. “India’s Fiscal Performance, in Nine Charts.” Livemint. February 16, 2020. Accessed May 4, 2020. https://www.livemint.com/news/india/india-s-fiscal-performance-in-nine-charts-11581857139177.html.

[10] RBI. Accessed May 4, 2020. https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/STATEFINANCE201920E15C4A9A916D4F4B8BF01608933FF0BB.PDF.

[11] Bureau, Our. 2020. “Covid-19 Impact: Budget Numbers of States Need Major Revisions, Says SBI Report.” @Businessline. The Hindu BusinessLine. March 31, 2020. Accessed May 4, 2020. https://www.thehindubusinessline.com/economy/covid-19-impact-budget-numbers-of-states-need-major-revisions-says-sbi-report/article31219925.ece.

[12] Bureau, Our. 2020. “States Petition Centre for Economic Lifejacket.” @Businessline. The Hindu BusinessLine. May 1, 2020. Accessed May 4, 2020. https://www.thehindubusinessline.com/economy/policy/states-petition-centre-for-economic-lifejacket/article31484147.ece.

[13] . The Wire. Accessed May 4, 2020. https://thewire.in/political-economy/15th-finance-commission-states-covid-19.

[14] Ohri, Nikunj. 2020. “What India Has Released From Its Rs 1.7 Lakh Crore Relief Package For The Poor .” BloombergQuint. Bloomberg Quint. April 14, 2020. Accessed May 5, 2020. https://www.bloombergquint.com/coronavirus-outbreak/what-india-has-released-from-its-rs-17-lakh-crore-relief-package-for-the-poor.

[15] Ohri, Nikunj. 2020. “What India Has Released From Its Rs 1.7 Lakh Crore Relief Package For The Poor .” BloombergQuint. Bloomberg Quint. April 14, 2020. Accessed May 5, 2020. https://www.bloombergquint.com/coronavirus-outbreak/what-india-has-released-from-its-rs-17-lakh-crore-relief-package-for-the-poor.

[16] Srivastava, Ravi. 2020. “No Relief for the Nowhere People.” The Hindu. The Hindu. May 3, 2020. Accessed May 5, 2020. https://www.thehindu.com/opinion/op-ed/no-relief-for-the-nowhere-people/article31495460.ece.

[17] Kannan, KP. 2020. “No Excuse for a Niggardly Covid-19 Relief Package.” @Businessline. The Hindu BusinessLine. April 13, 2020. Accessed May 5, 2020. https://www.thehindubusinessline.com/opinion/india-needs-a-better-covid-19-relief-package/article31297141.ece.

[18] Rajan, Ramkishen S., and Sasidaran Gopalan. 2020. “COVID-19 and India’s Fiscal Conundrum.” The Hindu. The Hindu. May 5, 2020. Accessed May, 5, 2020. https://www.thehindu.com/opinion/op-ed/covid-19-and-indias-fiscal-conundrum/article31504085.ece.

[19] “Centre for Policy Research.” 2020. Analysis: How Secure Are Construction Workers in India During COVID-19 Pandemic? | Centre for Policy Research. April 1, 2020. Accessed May 5, 2020. https://www.cprindia.org/news/8724.

[20] Pti. 2018. “Need a Monitoring Mechanism to Ensure Prompt Use of Funds under DMF: Parliamentary Panel to Mines Ministry.” The Economic Times. Economic Times. December 30, 2018. Accessed May 5, 2020. https://economictimes.indiatimes.com/industry/indl-goods/svs/metals-mining/need-a-monitoring-mechanism-to-ensure-prompt-use-of-funds-under-dmf-parliamentary-panel-to-mines-ministry/articleshow/67308833.cms?from=mdr.

[21] “Covid-19 Update: Row over Migrants’ Rail Fare as Congress Offers to Foot the Bill.” 2020. Hindustan Times. May 4, 2020. Accessed May 5, 2020. https://www.hindustantimes.com/india-news/row-over-migrants-rail-fare-as-cong-offers-to-foot-the-bill/story-XrPFuQeVL9Mu3irfpbAQgM.html.

[22] http://www.ETHealthworld.com. 2020. “Donations Pour in but India’s ‘PM CARES’ Coronavirus Fund Faces Criticism – ET HealthWorld.” ETHealthworld.com. April 8, 2020. Accessed May 5, 2020. https://health.economictimes.indiatimes.com/news/industry/donations-pour-in-but-indias-pm-cares-coronavirus-fund-faces-criticism/75047270.

[23] Bloomberg. 2020. “The Steps India Has Taken so Far to Contain Economic Fallout of Covid-19.” The Economic Times. Economic Times. April 22, 2020. Accessed May 5, 2020. https://economictimes.indiatimes.com/news/economy/policy/the-steps-india-has-taken-so-far-to-contain-economic-fallout-of-covid-19/articleshow/75285944.cms?from=mdr.

[24] Rajan, Ramkishen S., and Sasidaran Gopalan. 2020. “COVID-19 and India’s Fiscal Conundrum.” The Hindu. The Hindu. May 5, 2020. Accessed May 5, 2020. https://www.thehindu.com/opinion/op-ed/covid-19-and-indias-fiscal-conundrum/article31504085.ece.

[25] Rajan, Ramkishen S., and Sasidaran Gopalan. 2020. “COVID-19 and India’s Fiscal Conundrum.” The Hindu. The Hindu. May 5, 2020. Accessed on May 5, 2020. https://www.thehindu.com/opinion/op-ed/covid-19-and-indias-fiscal-conundrum/article31504085.ece.

[26] Mishra, Asit Ranjan. 2020. “Retail Inflation Eases to 4-Month Low in Mar on Lower Food Prices.” Livemint. April 13, 2020. Accessed on May 5, 2020. https://www.livemint.com/news/india/retail-inflation-eases-to-below-6-in-march-11586779208538.html.

[27] Sikarwar, Deepshikha. 2020. “Talks Held on Separate Covid Budget.” The Economic Times. Economic Times. April 18, 2020. Accessed on May 5, 2020. https://economictimes.indiatimes.com/news/economy/finance/talks-held-on-separate-covid-budget/articleshow/75209728.cms?from=mdr.

[28] Kannan, KP. 2020. “No Excuse for a Niggardly Covid-19 Relief Package.” @Businessline. The Hindu BusinessLine. April 13, 2020. Accessed on May 5, 2020. https://www.thehindubusinessline.com/opinion/india-needs-a-better-covid-19-relief-package/article31297141.ece#.

[29] Yadav, Jyoti, Fatima Khan, and Policy Research. 2020. “Covid Fight Will Leave States Exhausted. India Needs to Re-Think Its Funds Transfer System.” ThePrint. May 4, 2020. Accessed on May 5, 2020. https://theprint.in/opinion/covid-fight-will-leave-states-exhausted-india-needs-to-re-think-its-funds-transfer-system/414036/.

[30] NIPFP. Accessed May 5, 2020. https://www.nipfp.org.in/media/medialibrary/2019/11/WP_282_2019.pdf.

[31] Yadav, Jyoti, Fatima Khan, and Policy Research. 2020. “Covid Fight Will Leave States Exhausted. India Needs to Re-Think Its Funds Transfer System.” ThePrint. May 4, 2020. Accessed on May 5, 2020. https://theprint.in/opinion/covid-fight-will-leave-states-exhausted-india-needs-to-re-think-its-funds-transfer-system/414036/.

[32] Amey Tirodkar. 2020. “COVID-19 Lockdown: Maharashtra Govt Announces Budget Cuts, No to New Projects and Recruitment.” NewsClick. May 5, 2020. Accessed on May 5, 2020. https://www.newsclick.in/COVID-19-lockdown-maharashtra-govt-announces-budget-cuts-no-new-projects-recruitment.

[33] Sharma, Sharad, and Debanish Achom. 2020. “Delhi To Charge 70% ‘Corona Fee’ On Liquor From Today.” NDTV.com. May 4, 2020. Accessed on May 5, 2020. https://www.ndtv.com/india-news/delhi-to-charge-extra-70-tax-on-liquor-from-tomorrow-amid-coronavirus-crisis-2223273.

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Despite a brutal second wave with cases peaking in April-May 2021, India’s Gross Domestic Product (GDP) grew at a record pace of 20.1 percent in the April-June 2021 quarter compared to the corresponding period last year. The GDP, in absolute terms, stood at Rs 32.38 lakh crore (constant prices). This was actually lower by 9.2 percent than the numbers seen in the April-June quarter of 2019-20. In fact, as the figure below shows, the April-June 2021 GDP numbers are closer to the levels seen during the January-March 2017 quarter.

Source: MOSPI (Annual and Quarterly Estimates of GDP at constant prices, 2011-12 series)

While growth in the April-June 2021 quarter is promising and reflects recovery from the deep plunge seen in April-June 2020, comparisons are being drawn with the pre-Covid levels. 

But what are these pre-covid levels? Should numbers of a single quarter, say April-June 2019-20 be used as the benchmark, or an average growth seen in the previous few quarters be considered as a benchmark for comparison? 

An alternate strategy

We propose an alternative way through which, we compare the present Gross Value Added (GVA) numbers (in level terms) with the numbers obtained using simple univariate time-series forecasts. These forecasts are obtained by exploring the time-series properties of the variable of interest. In particular, these forecasts are arrived at using the Autoregressive Integrated Moving Average models (ARIMA models). ARIMA is a statistical analysis model that uses time-series data to better understand the facts and to predict future trends. 

This comparison helps in assessing how distant are the current GVA numbers from the levels which would have been achieved had there been no shock in the form of the COVID-19 pandemic.   

Since GDP includes taxes, we look at the activity-based variable after excluding the impact of taxes. The variable of interest, therefore, is the Gross Value Added (GVA). We use the GVA data available from June 2011 till December 2019 and extend it using the projections obtained from a univariate ARIMA model. As mentioned before, in this model previous observations are used to predict future values. Therefore, we have excluded the period post-December 2019 to ensure that the trend is not influenced by the COVID-19 shock. 

The figure below shows the raw data along with the projections for the subsequent six quarters (from March 2020 onwards) based on the ARIMA model. These projections present a picture of the GVA trends under normal circumstances, i.e. if the economy would not have been subjected to the COVID-19 shock.

Adjustment for seasonality 

An economy, over the long term, experiences a concept known as seasonality. These are seasonal fluctuations, movements, that recur with similar intensity in a given period (such as months) each year, thus showing a clear pattern of peaks or troughs over a sufficiently long time period. Broadly, seasonality arises from several calendar related events such as – weather-based factors: monsoon, winter or summer months, agricultural seasons: harvest or sowing season, administrative procedures: tax filings, financial year closure, working days, festivals: Diwali, Christmas, etc., institutional: Annual budgets or Fiscal year ending, social and cultural factors: Statutory holidays, etc.

Such seasonality needs to be adjusted to comprehend the underlying trend, cyclicality, and other movements for a better understanding (Pandey et. al, 2020). 

The quarterly GVA series shown above exhibits seasonality and therefore we seasonally adjust the extended GVA series (GVA values till December 2019 along with the forecasted values) and compare with the seasonally adjusted actual data post-December 2019.  

The difference between the series till December 2019 extended with time-series forecasts and actual series post-2019 (both adjusted for seasonality) would give an assessment of the shortfall in economic activity arising due to the COVID-19 shock. 

Shortfall due to COVID-19

The table below shows the differences between the estimates based on the time-series forecasting and the actual values. We present this exercise for the overall GVA as well as its components. The key highlights of the comparison exercise are as follows:

Table 1: Difference between the Actual values and Estimated values (Rs. Lakh Cr)

*Both Actual and Estimated Values are seasonally adjusted

1. In the January-March 2020 quarter, the difference between the forecasted (estimated) values and the actual values is small. This is due to the limited impact of the pandemic during this quarter. 

2. However, the difference widened to Rs 8.7 lakh crore in the April-June 2020 quarter. This was the period of the nationwide lockdown. As a result, the economic activity was adversely impacted. The major difference was seen in the contact-intensive trade, hotels, and transport sectors. Since agriculture was not impacted by the pandemic, the projected and the actual agricultural GVA is the same. 

3. With the gradual opening up from the July-September quarter, we see that the gap between our estimates and actual values is reduced. However, the financial sector continued to reel under the impact of the pandemic. While some improvement was seen in the GVA of the trade, hotels, and transport sectors in the July-September quarter, there still was a significant shortfall of Rs. 1.4 lakh crore.4. In the October-December 2020 and the January-March 2021 quarter, a distinct improvement is seen in the actual overall GVA numbers. The gap between the estimated and the actual values for the overall aggregate GVA narrowed to Rs 0.8 lakh crore and Rs. 0.3 lakh crore for Oct-Dec 2020 and Jan-Mar

2021 quarter respectively. Except for the trade, hotels, and transport sector, the gap was less than Rs 1 lakh crore for all the sub-sectors. 

5. But, the April-June 2021 quarter revealed that the gap has widened to the tune of Rs. 5.3 lakh crore. This shows that while the recovery was underway, the onset of the second wave and the consequent partial lockdowns pulled back the growth momentum to some extent. The sectoral variations are also worth noting. While agriculture, mining, and manufacturing showed stellar performance despite the second wave, the contact-based services sector (trade, hotels and transport) pulled down the growth. The construction sector also bore the brunt of the second wave.

The above exercise presents an alternative approach to assess the shortfall in GVA numbers due to the COVID-19 shock. There are sectoral variations: while agriculture posted a robust growth and the manufacturing sector was relatively less impacted, it is the contact-intensive sector that primarily got affected due to the shock. Our exercise shows that after the April-June 2020 quarter, the economic recovery was gaining momentum. However, the second wave led to a pause in the recovery process. 

Going forward, with a sustained pick-up in the pace of vaccinations, we should see economic recovery getting back on track. The high-frequency variables such as exports, PMI manufacturing and services, petroleum products consumption, electricity consumption, and GST collection, etc., also suggest a pick-up in economic activity since the beginning of the second quarter. 

The authors are Senior Fellow and Fellow respectively at the National Institute of Public Finance and Policy (NIPFP), New Delhi. Views are personal.

The Union Budget for FY 2021-22 presented on February 1, 2021 has the distinction of being the first budget after Covid-19 devastated much of the world, including India. India registered a historic contraction of nearly 24% in its Gross Domestic Product (GDP) in the first quarter of the current financial year, unemployment surged, small enterprises suffered acutely and vulnerable households slipped into poverty. During the course of the year, the government announced a series of measures to alleviate the Covid-19 induced stress. Since then, there have been signs of a nascent recovery in the economy. In this context, there has been tremendous anticipation around this budget to put India firmly back on the growth path. 

Towards this end, the budget has made many noteworthy announcements. Two key announcements stand out viz., a push to the privatisation agenda by announcing the privatisation of two public sector banks and an insurance company, and the establishment of an asset reconstruction company to take over the Non-Performing Assets (NPAs) of banks. 

Privatisation of public sector banks

Signalling a clear and key policy shift, the government has announced an ambitious and strategic privatisation policy by proposing to disinvest/strategically sell public sector entities (PSEs). Towards this end, the government has approved four sectors as strategic, where it will retain a minimum number of entities. It will pare down its presence above this minimum in strategic sectors, and completely in non-strategic sectors. Notably, banking, insurance and financial services have been identified as  strategic sectors.  

A number of central PSEs (including Air India, Shipping Corporation of India and the Container Corporation of India) have also been identified by the budget for divestment this fiscal year. Further, the NITI Aayog has been tasked with identifying the next pipeline of central PSEs for disinvestment.  Within this overall context, the current budget has also proposed to privatise two public sector banks (PSBs) in addition to Industrial Development Bank of India (IDBI), and a general insurance company.  

Privatisation of PSBs is not a new idea. It was attempted earlier as well.  The former Finance Minister, Yashwant Sinha, proposed to bring government stake below 51% in PSBs in early 2000s. However, this did not garner enough support. Given the burgeoning requirement of capital by PSBs and the limited fiscal space with the government, it has now become imperative to find other avenues to bridge the gap.  The proceeds of the disinvestment could help release government resources to more productive uses, particularly as government finances too have come under tremendous pressure in the wake of the pandemic.  

Moreover, with the approval of banking as a strategic sector, and the maintenance of public sector presence, the government should be able to avoid any compromise on its social agenda – a key concern that has been flagged earlier on privatisation of banks. 

Resolution of bad assets

Flow of credit is an imperative to meet the needs of a growing economy. A surge in bad or non-performing assets impedes the flow of credit. This is because banks must make higher provisioning to cover their bad assets, reducing the overall credit available to firms and households. It also makes banks risk averse. 

Measures to provide relief to borrowers such as the moratorium on loans – could exacerbate the problem of bad loans. An improvement in the NPA ratio of the banks was visible before the pandemic but the policy support extended to borrowers could impact the asset quality of banks through postponement in recognition of bad assets. 

The Financial Stability Report released by the Reserve Bank of India (RBI) in January this year estimates a sharp rise in the stressed assets on the banks’ books, particularly in the case of public sector banks. A number of measures were taken by RBI to improve the flow of credit by banks; however, the offtake of credit is still slow. The need of the hour therefore is to resolve these bad assets and clean up banks’ balance sheets so they can begin to lend more freely. 

The budget tries to address the problem of bad loans by announcing an asset reconstruction company (ARC) and an asset management company (AMC). This mechanism is expected to take over the stressed assets from banks, manage and eventually dispose them for value. The assets may be disposed of to potential buyers which include alternative investment funds (AIFs).  

The idea of a “bad bank” has apparently been inspired by the experience of countries such as the US and Malaysia. The Malaysian government, for instance, set up “Pengurusan Danaharta Nasional Burhad” – a government-backed AMC – that successfully bought and resolved bad assets in the Malaysian financial system in the aftermath of the Asian Financial Crisis in late 90s. 

While details on the Indian initiative are sparse at this point, the proposed mechanism is understood to not be a government owned entity. Instead, this mechanism would be primarily led by banks, with the government offering some support – perhaps in the form of a guarantee. The success of this proposal would depend on how well the proposed entity is managed. It will also depend on the capital allocation strategy by banks and how much money the government sets aside for this entity.

The reference to Alternate Investment Funds (AIFs) and other entities as potential buyers perhaps hints at measures for improving the efficiency of the stressed assets market – an important step that must go hand in hand with the creation of a “bad bank”.  However, a pitfall that the proposed mechanism must guard against is the potential “moral hazard”. It must disincentivise, rather than incentivise, poor decision making by the banks that led to the bad assets in the first place. 

Both the above announcements mark important interventions in the banking sector. Their success will however depend on the actual details – of the institutional structures and enabling frameworks put in place. Implementation will also be key, given the competing interests when it comes to privatisation and the government’s own poor track record on divestment.  This will, therefore, be a keenly watched space in the coming year.  

The views expressed in the post are those of the author and in no way reflect those of the ISPP Policy Review or the Indian School of Public Policy. Images via open source.

On February 01, 2021, Finance Minister Nirmala Sitharaman introduced the Budget for FY 2021-22 in the Parliament. Budget announcements are always a highly anticipated event in India; this time the expectations were even higher for the government to provide a credible roadmap for recovery. However, ahead of the Budget, another bill rumored to be proposed during the session was making news. The to-be-proposed Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 has taken the nascent crypto-industry in India by surprise. The Bill has dual objectives of (i) banning ‘private’ cryptocurrencies in India and (ii) creating a framework for the Reserve Bank of India to issue official digital currency. While further details on the Bill are awaited, now is an opportune time to look at the current status of digital currencies in India and around the world.

The Reserve Bank of India (RBI) has viewed cryptocurrencies with a jaundiced eye. In April 2018, the RBI issued a circular, “prohibiting banks and entities regulated by it from providing services in relation to virtual currencies.” The circular was subsequently overturned by the Supreme Court on grounds of being a “disproportionate” response by the RBI. It further asserted that there was no evidence that any regulated entities had indeed incurred losses or instability on account of virtual currencies. 

Understanding Digital Currency

For a preliminary understanding of digital currency, one can look towards its most popular example – BitCoin. It was launched against the backdrop of the 2008 global financial crisis (GFC) as a bulwark against excessive printing of currency by central banks. The mystery surrounding the inventor, the legendary Mr. Satoshi Nakamoto, only added to the allure of the new digital currency. Here was a currency that was decentralized and maintained user anonymity while ensuring complete transparency for all transactions. BitCoin is limited to 21 million units, which are mined by solving complex mathematical problems (a.k.a. proof of work) and can then be traded on BitCoin exchanges. Blockchain technology, upon which BitCoin is built, has a certain democratic appeal; blockchain ledgers are immutable and can be changed only when such a change is validated by a given number of participants. Despite these advantages, there has been criticism against BitCoin or any of the non-fiat digital currencies to be used as a reserve currency, especially on account of limitations to being used as a medium of exchange

Opportunity for a Central Bank Digital Currency

In recent years, and perhaps consequentially, central banks around the world have begun to evaluate the possibility of a sovereign-backed digital currency also known as a central bank digital currency or a CBDC. This begets an obvious question – what indeed is a CBDC? Traditionally, money comprises cash, deposits maintained by commercial banks with the central bank and deposits with commercial banks. A CBDC introduces a new form of digital money which is a liability of the central bank. In theory, even retail participants could hold a CBDC in the future. Secondly, one might wonder, what are the motivations for issuing such a form of money? A report published by the Bank for International Settlements (BIS) in 2020 broadly categorizes the merits and risks of a CBDC as follows:

a. Payment systems – motivations and challenges

This category includes a multitude of motivations such as ensuring continued access to risk-free money in societies where cash is going out of fashion, improving financial inclusion, enhancing efficiency of cross-border payments, etc. Key risks in this category include ensuring cyber resilience and balancing public privacy needs with anti-money laundering requirements.

b. Monetary policy – motivations and challenges

If CBDCs are designed as interest-bearing instruments, then monetary policy transmission would, in theory, be immediate. This could incentivize commercial banks to accelerate passing on the effects of changes in policy rates. Whether CBDCs should indeed be interest-bearing instruments is a design challenge requiring further study.

c. Financial stability – motivations and challenges

A key motivation for central banks to evaluate issuance of CDBCs is to pre-empt the risk of loss of monetary sovereignty on account of displacement by privately issued digital currencies such as Diem (previously called Libra) by Facebook. However, introducing a CBDC introduces the possibility of a bank run in times of crisis from commercial deposits to central bank money.

Way Ahead

Money is an economic, social, and political phenomenon. Introduction of CBDCs requires careful planning, analysis, and balancing risks with efficiency motivations. Design choices abound in terms of technological architecture as well as features embedded in the instrument. In the Indian context, a well-designed pilot project aligned with social and economic realities is paramount. Internationally too, interest in CBDCs has increased, partially on account of the COVID-19 pandemic. A survey conducted by the BIS in 2020 revealed that 86% of central banks (out of a total of 65 respondents) were actively engaged with CBDC research, evaluation, and/or development (see figures below). China famously leads the pack in digital currency development adding a currency dimension to its competition with the United States.

Figure 1 Source: BIS Central bank survey on CBDCs. 1 Share of respondents conducting work on CBDCs.

Adoption of new technology is often scary, and rightly so, especially in cases where it has the power to improve or destroy entire systems. India’s financial system has been revolutionized by fintech, especially in the digital payments space. It is indeed time we re-visited the idea of money in light of the technology now available at our disposal. The to-be-proposed Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 signals India’s willingness in this regard.

The views expressed in the post are those of the author and in no way reflect those of the ISPP Policy Review or the Indian School of Public Policy. Images via open source.