Robust capital expenditure by states crucial for economic recovery: RBI

A revival in capital expenditure by the Centre and states in the second half of the financial year is imperative for sustaining the momentum of economic recovery, the Reserve Bank of India said in its monthly bulletin.

“Capital expenditure, which collapsed in H1 FY21, will need to be scaled up as a priority. Public investment in healthcare, social housing, education and environmental protection is the need of the hour to build a more resilient and inclusive economy,” the RBI said in an article titled “Government Finances 2020-21: A Half-Yearly Review”.

The first two quarters of FY21 saw a poor focus on capex from the states’ side, data presented in the article, showed.

For instance, while the Centre spent 21.4 per cent of the budgeted (BE) capex in Q1, states spent only 7.3 per cent. In the second quarter, the pace of spending slowed down for the Centre, as it spent 18.8 per cent of annual budgeted capex. Though states improved from Q1, they spent only 12.7 per cent of annual plan in Q2.

But on the revenue front, the Centre faced a stronger dip than the drop experienced by states, the article showed.

Referring to fiscal multipliers—ratio of change in economic output for a change in expenditure, to put it simply—the article said that capex by the Centre has a multiplier of 2.45 in that specific year, and to the tune of 3.14 in the succeeding year. Similarly, capex done by states has a multiplier of 2.

“States, which constitute around 60 per cent of the general government capex with a fiscal multiplier above 2, may resort to a cut in capex in 2020-21, which may act as a drag on revival of investment and overall growth,” the article noted.

On its part, the stimulus played an important role in prioritising spending in 2020-21, though as the level of spending remained close to last year’s levels. But more importantly, the nature of the stimulus also changed over time.

“The size and composition of the stimulus coupled with its calibrated shift in focus from consumption to liquidity to investment suggest that it is growth giving, more via investment revival channel, with a large part of the impact expected to accrue in the second half of the year,” the RBI bulletin said.

Another article presented in the December bulletin showed how nature of support changed across different rounds of stimulus measures.

It showed that while reviving consumption has been the continuing theme of the stimulus, the initial focus on in-kind transfers and liquidity was replaced by a focus on investment revival.

The impact of stimulus, however, is limited by the quality of expenditure, the bulletin noted.

Government spending will add 159 basis points to growth in FY21, and a similar thrust of 158 basis points in FY22, the article said. One basis point is a hundredth of a percentage point.

Going forward and assuming a major expenditure push in Q3 and Q4 of 2020-21 (FY21), the RBI projected a combined gross fiscal deficit (Centre and states together) at 8.3 per cent of gross domestic product in Q3, to further rise to 12.4 per cent of GDP in Q4.

Across the four quarters of a financial year, gross fiscal deficit to GDP ratio usually declines, as governments front-load their expenditures. But this year, even the last quarter may see a jump in fiscal deficit, suggesting that the much awaited number may be higher than expected this year.

The government will officially release the revised estimate of revenue, expenditure and the fiscal deficit for FY21 during the annual Budget on February 1, 2021.