Date: 16/12/2022

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. Government Budgeting.

Key Phrases: Budget, Capex, Fiscal Deficit, Fiscal Consolidation, Pandemic, Government, Special Duty, Surcharge, Current Expenditure Subsidies, Commodity Prices.

Context:

• The Capex track record over the last few years has been weak.
• The most important change during the pandemic was, the overall fiscal deficit of the government soared.
• With the budget season approaching soon, there is hope that fiscal consolidation can coexist with high Capex.

Key Highlights:

• The 2023-24 Union budget will be announced on February 1, followed by the states’ respective budgets. This will set the policy tone for the rest of the year.
• As the overall fiscal deficit of the government has soared it is believed that the next few years will be all about getting it back on track.
• This is important because interest payments on past debt make up to 50 per cent of net tax revenues for the central government, leaving very little room for other spending.
• It is important to lower the interest burden over time as the focus needs to be shifted to various economic fronts like health, education and capex.
• This can be achieved by fiscal consolidation.

What is Capital Expenditure?

• Capital expenditure is the money spent by the government on the development of machinery, equipment, building, health facilities, education, etc.
• It also includes the expenditure incurred on acquiring fixed assets like land and investment by the government that gives profits or dividend in future.

Understanding Capital Expenditure:

• Capital spending is associated with investment or development spending, where expenditure has benefits extending years into the future. Capital expenditure includes money spent on the following:
  • Acquiring fixed and intangible assets
  • Upgrading an existing asset
  • Repairing an existing asset
  • Repayment of loan

Why Is Capital Expenditure Important?

• Capital expenditure, which leads to the creation of assets is long-term in nature and allows the economy to generate revenue for many years by adding or improving production facilities and boosting operational efficiency.
• It also increases labour participation, takes stock of the economy and raises its capacity to produce more in the future.
• Along with the creation of assets, repayment of loans is also a capital expenditure, as it reduces liability.

How Is Capital Expenditure Different From Revenue Expenditure?

• Unlike capital expenditure, which creates assets for the future, revenue expenditure is one that neither creates assets nor reduces any liability of the government.
• Salaries of employees, interest payment on past debt, subsidies, pension, etc, fall under the category of revenue expenditure. It is recurring in nature.

What Does The Path For Fiscal Consolidation Look Like For The Central And State Governments?

• The performance of central and state finances has been different for at least four reasons:
  1. Central government tax revenues have risen faster than state revenues. Both benefitted as small and informal firms struggled with the lockdowns and lost market share to large firms, which tend to pay more taxes.
     • The reason for the disparity- A large chunk of the tax revenues in the early part of the pandemic period came from the “special” duty and surcharge on oil, which went primarily to the central government.
     • The central government subsequently cut the duty on oil (in both 2021-22 and 2022-23) and the tax share that went to the states rose.
  2. The Centre has committed to more current expenditure than the states. This was led by higher social welfare spending (for instance, on the free food distribution scheme) and, more recently, higher subsidies (for example, fertilisers) in the face of rising commodity prices.
     • The common perception is that states have gone all out on unsustainable current expenditures but the data shows that it’s just a few states which have spent heavily (for example, Telangana, Assam, West Bengal and Punjab).
  3. The central government capex has risen but state capex has contracted.
     • The central government used both its tax collection and its ability to borrow more to raise capex spending, which rose by 1.2 per cent of GDP between 2019-20 and 2021-22.
     • However, the states cut back on capex, which has fallen as a percentage of GDP over the last few years, and continues to be on a weak footing in the current year.
  4. The central government’s fiscal deficit has overshot targets while the state deficit is relatively contained.
     • The central government’s fiscal deficit has risen above the pre-pandemic level of 3.4 per cent in 2018-19, and is well above the 3 per cent medium-term target.
     • Even though the state fiscal deficit rose in the first year of the pandemic (from 2.5 per cent of GDP in 2018-19 to 3.8 per cent in 2020-21), it has fallen sharply since (to 2.7 per cent in 2021-22).

Common Challenges:

• To commit to more capex, which is considered high quality spending as it “crowds in” private investment if done responsibly.
• It is believed that investment is the only sustainable way to increase the capacity of the economy to grow and create jobs.
• For the central government, the challenge is to hold on to its capex push at a time of fiscal consolidation.
• For the state governments, the challenge is to start doing more.

Conclusion:

• The central government’s aim is to lower the fiscal deficit by about 2 percent of GDP over the next three years.
• About half of this consolidation can come from lowering current expenditure to pre-pandemic levels. But the balance must come from one of the following.
  • Continued formalization of the economy that raises tax revenues.
  • A bigger push for disinvestment by selling stakes in public-owned companies.
  • Further tax reforms (in terms of direct taxes and the GST).
  • If these don’t work, the default option will be to cut capex, which is a concern as it has implications for medium-term growth.
• For the states, the tax revenue has so far been used for fiscal consolidation and current expenditure. The capex track record over the last few years has been weak.

Source: Indian Express

Mains Question:

Q. Given the needs of the economy on various fronts like health, education and capex, it is important to lower the interest burden over time through fiscal consolidation. Comment. (150 words).