Tight-fisted Budget leads to capex squeeze, and it's not surprising anymore

With every passing year, the absence of big-ticket investment announcements in Union Budgets seems to surprise less. The share of the government's capital expenditure has been showing a declining trend in the last two decades.

Tightening fiscal conditions, for a variety of reasons, have had a disproportionate impact on the government's capital spending over the years, shows research. Earlier, the governments could get the central bank to create the cash they needed to meet the shortfalls. But this monetisation of fiscal deficit caused inflationary problems, so governments were required to spend within their limits through various moves, including the Fiscal Responsibility and Budget Management (FRBM) Act, 2003. As these moves bore fruit, it was seen that the spending cuts had been more on the capex side rather than on revenue expenditure. 

"Since the introduction of the FRBM Act in 2003, authorities have been under pressure to keep the fiscal balance in check, and the brunt of this expenditure control has been borne by capital expenditure," noted 'Government Expenditure in India: Composition, Cyclicality and Multipliers', a December 2015 working paper by Indira Gandhi Institute of Development Research authors Ashima Goyal and Bhavyaa Sharma. Governments have shown a tendency to lower capital expenditure, which are to show results over the longer term.

Capital expenditure refers to money spent on the creation of long-term assets, such as roads and other infrastructure.  Revenue expenditure refers to expenses such as salaries, and interest payments. The government provides a split between the two as part of the Budget.

The capital expenditure share in Budget 2019 was the second-lowest in 20 years at 12.15 per cent, according to a Business Standard analysis of previous Budgets. The last time it was so low was in the year 2009-10, when the share of capex was 12.11 per cent.

Various studies have shown that there is a higher positive impact if the government undertaked capital expenditure rather than revenue expenditure. This is because it also helps ramp up private investment leading to a multiplier effect on growth in gross domestic product (GDP). The capital expenditure multiplier is 2.45, according to a National Institute of Public Finance and Policy (NIPFP) paper.

“A value of 2.45 for capital expenditure multiplier implies that an increase in capital expenditure of the government by Rs 1 crore would raise the GDP by Rs 2.45 crore by the end of the year, where both are measured in nominal terms. The thrust of government expenditure expansion has to shift in favour of capital expenditure,” said the 2013 paper ‘Fiscal Multipliers for India’ authored by NIPFP consultant Sukanya Bose and professor N R Bhanumurthy.

The share of capital expenditure peaked at 19.32 per cent in 2005. There has been a declining trend in the years since then. And the outlook for the current year is not optimistic.

Less capital expenditure not only hampers the creation of new assets, which fuel future growth, but also leads to less robust growth in the government's total expenditure.

Budgeted spending runs the risk of downward revisions, because the government may not have enough money due to tax revenue shortfalls, according to Sachchidanand Shukla, chief economist at Mahindra and Mahindra. “Total government expenditure as a percentage of GDP may well be at its lowest level in years,” he said.

“Headline deficit forecasts remain at 3.4 per cent of GDP, but revenue assumptions look aggressive (25 per cent YoY growth in an economy with under 11 per cent nominal GDP growth); and are likely to be missed, in our view. Expenditure forecasts have been largely maintained from the FY20 interim budget (by ministry and by major schemes), but spending will have to be curtailed through the year,” according to a July 5 Bank of America Merrill Lynch Equity Strategy report authored by research analysts Sanjay Mookim and Nafeesa Gupta.

There may be limited headroom to push growth via states and off-Budget expenditure, according to global financial services firm UBS Securities India in its 10 July ‘Macro Key’ report.