Aamdani rupaiya, kharcha atthanni

If you’re not familiar with the Hindi language, the title of this post is a play on a fairly popular phrase: aamdani atthanni, kharcha rupaiya

In effect, your income is less than your expenses. Which, of course, isn’t a desirable state of affairs:

For all of the last decade, the primary metric for evaluating budgets was the fiscal deficit. How much would the government target to bring it down by, and how credible were the numbers? The source of that stress was the massive stimulus set in motion by the government well before the global recession showed up, as it was inundated by taxes in the 2006 to 2008 period. The challenge with that stimulus was that it was hard to roll back, much of it being a large increase in state and central government salaries and pensions.

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But we find ourselves in unchartered territory, says Neelkanth Mishra:

Tax collection is surprising positively, and should be more than 1 per cent of GDP higher than before the Covid-19 lockdowns (though assumptions are lower). Further, financial markets appear to be expecting both central and state governments to incur large fiscal deficits for several years, with the anchor shifting higher by 3 per cent of GDP. Let us assume that GDP being below where it was supposed to be if the pandemic had not happened means an extra per cent-and-a-half of costs for the government. Interest costs have risen as governments borrowed to bear a large part of the economic loss during the lockdowns. Further, some government expenses, like salaries and pensions, keep rising irrespective of the level of GDP. This still leaves 2.5 per cent of GDP of space for governments to increase spending.

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And as it turns out, it is unchartered territory for everybody, the government itself included. Neelkanth Mishra points out that we’re bringing off-budget items on to the budget, we’re paying off export incentives that were due, and the debt write-off for India has also been accounted for. Even so, he says, cash balances maintained by the government with the RBI are at an all time high.

So what can be done? Well, part of the answer this time around lies in asking the states to step up and spend on building out physical infrastructure:

The sharp increase in capital expenditure from Rs 5.45 trillion to Rs 7.5 trillion shows the intent of the government is to stay away from distributing freebies (commendable, given the upcoming state elections), and focus instead on productive spending, which may be rolled back if necessary. However, half of this increase is an allocation for interest-free loans to state governments for capital expenditure, and some of the rest is the inclusion of off-budget provisions in last year’s budget in the budget numbers this year. There are increases in the allocation for defence (particularly once adjusted for the lower spend on aircraft purchases this year), the Nal se Jal scheme, and for roads and railways, but these are incremental rather than substantial.
Allowing state governments more fiscal space (deficits up to 3.5 per cent of GDP are allowed, with another half a per cent if the state undertakes power sector reforms), and dangling the carrot of more funding if they undertake capital expenditure is the right approach in theory. Much of the necessary investments need to occur at the state level: Like in health, education, urban infrastructure, water supply, sanitation and power distribution. However, the gap between states’ intent to spend and their execution has widened substantially during the pandemic, and their total spending is far lower than budgeted, despite increases in non-discretionary expenses like interest costs, salaries and pensions.

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And the limiting factor there, ironically, is limited state capacity.

…many developing countries and organizations within them are mired in a “big stuck,” or what we will call a “capability trap”: they cannot perform the tasks asked of them, and doing the same thing day after day is not improving the situation; indeed, it is usually only making things worse. Even if everyone can agree in broad terms about the truck’s desired destination and the route needed to get there, an inability to actually implement the strategy for doing so means that there is often little to show for it—despite all the time, money, and effort expended, the truck never arrives.

Andrews, M., Pritchett, L., & Woolcock, M. (2017). Building state capability: Evidence, analysis, action (p. 10). Oxford University Press.

In other words, we have more money to spend this year, but our constraint is quite literally our inability to spend it usefully and efficiently.

It would be worth our collective while, then, to learn a little bit more about state capacity!