Last year, in their working paper titled India’s Great Slowdown: What happened? What’s the Way Out? for the Center for International Development at Harvard University, Arvind Subramanian and Josh Felman rang the alarm bells for the Indian economy. “Clearly, this is not an ordinary slowdown. It is India’s Great Slowdown, where the economy seems headed for the intensive care unit,” wrote the duo in the paper released in December. Subramanian is a former chief economic adviser (2014-2018) and Felman a former head of the International Monetary Fund’s India office.

They even suggested that India faces a “four balance sheet challenge” (as opposed to two balance sheets, as earlier noted by Subramanian in the Economic Survey of 2016-17): Bad-loan-encumbered banks, overleveraged corporates, distressed non-banking financial companies, and fiscally-challenged real estate players. And argued that the economy is trapped in “an adverse interest-growth dynamic, in which risk aversion is leading to high interest rates, depressing growth and generating more risk aversion”. Compounding the problem is that standard remedies are unavailable because “monetary policy is stymied by a broken transmission mechanism, and a large fiscal stimulus will only push up the already-high interest rates”.

Subramanian and Felman were only reiterating—and underscoring—the uphill task ahead for the government as it readies itself for another Union Budget: to revive a moribund economy even as it tries to keep the fiscal deficit in check. The problem is exacerbated by the fact that only one growth driver—government spending—is holding up the economy, while other areas—private consumption, exports, and private investments—contributing to aggregate demand are struggling.

A critical question, in this context, is “whether the fall [in aggregate demand] is a symptom of a larger structural problem”, asks Rathin Roy, director of the New Delhi-based think tank, National Institute of Public Finance and Policy. Roy, on his part, is convinced that the slowdown is structural, and not cyclical.

He explains: Over the past 20 years, India’s growth story has been defined by the rapidly rising purchasing power of its top 150 million people. Moreover, the consumption boom, he says, was fuelled by a change in relative prices in items favouring this class—fast-moving consumer goods, cars, consumer durables, and airline travel. None of those have seen a significant price spike. On the contrary, air ticket prices are lower than two decades ago, when adjusted for the hike in real interest rates.

However, the same benefits did not accrue to those earning minimum wages because the cost of nutritious meals, affordable clothes and housing, and reasonably good quality healthcare—important items in their consumption basket—not only continued to rise but was often volatile. As a result, once the top 150 million was satiated and stopped buying, the consumption boom went bust. (Those below the poverty line would, in any case, need government subsidies to afford such goods.)

The reason for the protracted slowdown— whether structural, cyclical, or a combination of both—notwithstanding, its impact is being felt across industries and sectors. GDP growth plunged to a 26-quarter low, to 4.5% in the second quarter of FY20 from 7% in the corresponding period in FY19; nominal GDP, at 6.1%, is the lowest in the new GDP series (evaluated at current market prices).

Worse, GDP growth is likely to fall to 5% in FY20, the lowest in the past 11 years, according to the First Advance Estimates of National Income 2018-19 by the Central Statistics Office, released on January 7. It doesn’t help that the advance estimate of the National Statistical Office points to a decline in private consumption—from 8.1% in FY19 to 5.8% in FY20— which constitutes 54.7% of the GDP.

Even manufacturing (16.7% of the GDP) has registered negative growth of -0.2% in the past six months—and is only likely to grow to 2% for the whole year, according to the advance estimate—compared to 9.5% in the first half of FY19. Similarly, coal production contracted by 10.3%, crude oil by 5.1%, natural gas by 2.6%, and mining by 1.2% in the second quarter of FY20. Capital goods production, too, registered negative growth in the March, June, and September quarters at -7.4%, -3.5%, and -16.4% as did tractor sales, down by 6.3%, 14.4%, and 11.5%, respectively. Inevitably, the fall in consumption demand has led to the worst decline in auto sales, including cars, SUVs and twowheelers, in the past two decades.

The drastic under-achievement in nominal GDP growth—real GDP growth plus inflation— from the budgeted 12% to 6.1% in Q2FY20 has made the situation worse. Ranen Banerjee, partner and leader, public finance and economics, advisory services, PwC India, points out that reduced nominal growth means lower tax collections (because taxes are paid according to nominal growth), more government borrowings and, therefore, higher fiscal deficit. In fact, there are those that contest the 3.4% fiscal deficit number of FY19 put out by the finance ministry. While the Comptroller and Auditor General has pegged it at 5.8% of the GDP in its submission to the 15th Finance Commission, Roy, a former member of the Economic Advisory Council to the Prime Minister, is more conservative, settling for 4.3%. The current macroeconomic situation indicates that fiscal deficit will stand at between 3.6% and 3.8%, say experts. “The fiscal deficit is likely to be higher than the budgeted 3.3% of the GDP [for FY20] because of the steep fall in the nominal GDP and a sharp decline in revenue growth,’’ says Dharmakirti Joshi, chief economist at credit rating agency CRISIL.

The biggest casualty of the economic slowdown has been the shortfall in revenue receipts, both in tax and non-tax collections. From April to December 2019, only five of the nine months saw the goods and services tax (GST) breach the psychological `1 lakh crore-mark in collections. The 2019 Union Budget had estimated collecting that amount on a monthly basis. This shortfall has added to the discomfort of the government. “Between April and November 2019, GST collections stood at ₹3,28,365 crore against the budgeted estimate of ₹5,26,000 crore—a shortfall of nearly ₹1,97,635 crore,” says a Motilal Oswal report. This excludes the ₹1.45 lakh crore tax giveaway in corporate tax reduction, according to the government’s own estimate. A Kotak Securities report from November says that the estimated net tax revenue shortfall of around ₹1.7 lakh crore may be bridged, to some extent, by expenditure savings, additional Reserve Bank of India (RBI) dividend, and slightly higher public sector undertaking (PSU) dividend receipts. However, it expects the “government fiscal deficit to touch 3.7% of the GDP and may also revisit the market borrowings of `7.1 trillion [ ₹7.1 lakh crore] in January”.

Banerjee of PwC India believes that the total shortfall could be restricted to ₹1 lakh crore-₹1.25 lakh crore—because of a one-time windfall gain of ₹1.76 lakh crore from the RBI (the amount of reserves the Bimal Jalan committee, set up in December 2018 by the central bank, recommended be transferred to the government), higher GST collection in the next three months, expenditure compression in its various programmes, and the likely gains from the government’s disinvestment programme. He also concurs with many economists and tax experts that the total outgo from corporate tax reduction is likely to cost the national exchequer ₹70,000 crore- ₹80,000 crore—and not the government-estimated ₹1.45 lakh crore figure—as several firms enjoy a plethora of tax exemptions. “However, the fiscal deficit will jump from the budgeted 3.3% to 3.6% of the GDP,’’ he adds.

₹2.1 lakh crore
Estimated shortfall in the Centre’s tax revenue collections in FY20, according to a recent report by Motilal Oswal.
5.8%
Likely growth in private consumption in FY20,according to the National Statistical Office in FY19, the corresponding figure was 8.1%.

Another estimate, this time from a recent Motilal Oswal report, pegs the central government’s shortfall (in tax revenue collections) at ₹2.1 lakh crore in FY20, following the shortfall of ₹1.5 lakh crore in FY19. Their calculation is based on data available up to October 2019. “The shortfall would amount to 10.3% of the Budget Estimate (BE), making it the highest-ever shortfall for the central government since FY09, the second-highest since FY02.’’ It could be even higher for “states… at ₹3.5 lakh crore as against ₹3 lakh crore in FY19. It will be 11% of the BE in FY20, following a 10.2% shortfall last year, and the second-highest shortfall in the past 18 years,’’ says the report. State governments have already started making noises about taking the Centre to court for non-payment of ₹62,000 crore of compensation cess—what the government earns from the sale of sin or luxury goods like liquor, tobacco, or high-end cars, but has to share with the states.

There is a two-pronged ask for the central government, then: One, to keep its fiscal deficit in check at a time when revenues are fast declining and two, to rev up the economy through further investments. Both problems need to be fixed in tandem, suggests Nilachal Mishra, partner and head, government advisory, KPMG India. “Given the current scenario, it is paramount to use a combination of measures which aims for fiscal consolidation and fuelling the country’s economic growth at the same time,” he says, “since a positive growth phase will lead to a multiplier effect in the economy—giving way to increased tax revenues and reduced fiscal deficit.”

One route is “expenditure compression’’. That is, reduce spending on various projects and subsidy outlays. The finance ministry has begun the process, capping all expenditure at 25% from the budgeted 33% for the last three months of FY20. It is also necessary to aggressively build non-tax revenues from disinvestment proceeds and find innovative ways of raising financing. For instance, push PSUs to borrow more to implement programmes that do not show up on the Centre’s balance sheet. (Total PSU borrowings have risen from 1% of the GDP in FY15 to 2.6% in FY19, according to a report by Kotak Securities.) The Budget had set an aggressive disinvestment target of ₹1.05 lakh crore, but proceeds till December-end were only ₹17,364 crore. Moreover, the strategic sale of Air India, Bharat Petroleum Corporation (BPCL), Container Corporation of India (Concor), and Shipping Corporation of India (SCIL) to private players, announced by the government, has yet to take off. Nor has the government’s plan to sell Tehri Hydro Development Corporation and North Eastern Electric Power Corporation to National Thermal Power Corporation fructified. But the last-minute sale of one PSU to another is always a possibility given the experience of the past two years—Hindustan Petroleum Corporation was sold to Oil and Natural Gas Corporation in FY18 for nearly ₹37,000 crore as was Rural Electrification Corporation to Power Finance Corporation for ₹14,500 crore in FY19.

₹3,28,365 crore
GST mop-up between April and November 2019, against the budgeted estimate of ₹5,26,000 crore—a shortfall of ₹1,97,635 crore.

However, strategic disinvestments of companies take six to 16 months—all the way from floating a global tender to the closure of the deal—says a recent report of foreign brokerage firm CLSA. In that context, the proceeds would only bulk up revenues of the next fiscal. The strategic divestment of BPCL, Concor, and SCIL can easily fetch the government ₹79,000 crore under current market conditions, says an HDFC report of November 26, 2019. The other way is to reverse the current slowdown and “hike spending on government schemes like Pradhan Mantri Kisan Samman Nidhi, which provides government assistance of ₹6,000 annually to every farmer, and the Mahatma Gandhi National Rural Employment Guarantee Act,’’ says Joshi of CRISIL, because getting growth back is key. All said and done, if the past is any indicator, the government is unlikely to relax its fiscal deficit target even in a difficult year and will choose to adjust its spending to keep the deficit in check. Even in FY18, the government only spent ₹1.3 lakh crore, or 0.7% of the GDP, of the budgeted amount because of lower revenue realisation. The spending cuts were directed at two items: Lower-than-budgeted food subsidy and reduced transfer of funds to the states.

Of course, the government continued to procure sufficient food grains from farmers. It only shifted the onus to the Food Corporation of India—the government’s official agency—to implement the plan. The resultant large debts did not show on Budget documents.

It won’t be a long wait to see what strategies the government employs this time to keep the fiscal deficit (seemingly) in control.

This story is published in the February 2019 edition of the magazine.

Follow us on Facebook, Twitter & YouTube to never miss an update from Fortune India. To buy a copy, visit Amazon.