How Advance Tax Payments and Government Spending Impact System Liquidity

As I mentioned in my post, Liquidity in the Indian Banking System: An Introduction, there are many factors that impact liquidity in the banking system. Today, I’m going to talk about the impact of government spending on system liquidity. 

From where does the Central Government get its spending money?

The Central Government (CG) finances its expenditures from its revenue and capital receipts. Provided below is a snap shot of the CG’s 2015-16 (Apr 15 - Mar 16) Receipts Budget. Look at the Budget Estimates for 2015-16 (last column). These figures are in Rs. Crore; I’m going to refer to them in Rs Billion; 1 Bn = 100 Crore.

Source: Ministry of Finance.  

So, the CG expects Total Receipts of Rs. 17,775 Bn in 2015-16, comprising of Rs. 9,198 Bn in Net Tax Revenue, Rs. 2,217 Bn in Non-Tax Revenue, Rs. 5,436 Bn in Debt Receipts and Rs. 803 Bn in Non-debt Capital Receipts.

The amount of excess cash that the government has on any given day depends upon the trajectory of the above-mentioned Receipts (how they come in during the year), and the simultaneous expenditure that the government keeps incurring based on its Expenditure budget. This cash is held in the Central Government’s account with the RBI and is disclosed in the RBI’s daily Money Market Operations (MMO) bulletin under the head “Government of India Surplus Cash Balance Reckoned for Auction”. The RBI started disclosing this balance starting April 7th 2015, after repeated requests from market participants.

Government's Cash Balance with the RBI spikes and System Liquidity tightens following Advance Tax inflows

As you can see from the table above, the government’s top source of revenue is Tax Receipts. Amongst these, Advance Tax receipts are the ones that move the CG's cash balance the most. What is Advance Tax you ask? Advance tax basically refers to Income tax paid by an assessee (corporation, firm or individual) in installments across the financial year (FY), rather than in a lump sum at the end of the year. Any taxpayer with an income tax liability of Rs 10,000 or more in a FY is liable to pay Advance taxes. Such a system makes eminent sense, since a smooth flow of income tax receipts allows the government to carry out its works smoothly across the year. Note: in the Receipts Budget above, Advance Tax payments are made for 1) Corporation tax and 2) Taxes on Income.

For most of us salaried people, Advance Tax requirements are automatically fulfilled because of the TDS (Tax deducted at source) deducted by our companies/ employers from our pay-cheques every month. However, for assessees for whom TDS is not deducted, below are the due date for Advance Tax payments.

Advance Tax due dates for Companies 

Advance Tax due dates for assessees other than Companies 

Now that we know when Advance Tax Payments are due, let’s look at a chart of government cash balances to see if we can identify spikes around these due dates.

Government Surplus Cash Balance with the RBI (Rs. Billion)

Source: RBI MMO Bulletins, Nerdverve estimates

I’ve circled in the red, the cash balance on the days right after Advance Tax due dates. As is evident from the chart, the government's cash balance spikes up right after Advance Taxes are paid. 

To see how Advance tax payments flowing to the government impact system liquidity, I’ve used the chart for “Daily Net Liquidity in the Indian Banking System” from my previous post titled Liquidity in the Indian Banking System: An Introduction. I’ve circled the liquidity numbers on the 16th of Jun, 16th of Sep and 16th of Dec (a day after advance tax payments are made).

Estimated Daily Net Liquidity in the Indian Banking System (Rs. Billion). The red circles show the tightness in liquidity experienced right after Advance Tax Payments leave the system.

Source: RBI Weekly Statistical Supplements, Nerdverve estimates

It’s evident that there is a sharp liquidity squeeze right after advance tax payments are made to the government. This happens because funds leave corporate bank accounts (and thus the banking system) and enter the government’s account with the RBI. When this happens, they’re out of the system and out of circulation. They re-enter the system only once the government starts spending and/or surplus government cash is auctioned by the RBI. 

Seasonal Pattern of Government Spend 

Below is a chart of Government Final Consumption Expenditure (GFCE) by quarter at constant, 2011-12 prices, over the last 3 years. Note that GFCE includes only the government’s consumption expenditure and not the capital formation expenditure it incurs during the year. For 2015-16, GFCE is estimated at Rs. 11,386 Billion. The government’s total expenditure for 2015-16, including capital formation is estimated at Rs. 17,775 Billion. So, GFCE is ~65% of total Government expenditure for the year.

GFCE by Quarter (Rs. Billion) 

Source: MOSPI’s press note on Advance Estimates of National Income 2015-16 and quarterly estimates of GDP for the 3rd quarter of 2015-16, Nerdverve estimates

While I can’t comment on the trajectory of the capital formation expenditure that the CG incurs during year, GFCE does tend to follow a seasonal pattern (as seen in the chart above). In FQ4 (Jan-Mar), as the current fiscal year ends, spending is restrained (usually the lowest of all quarters). It picks up in FQ1 (Apr-Jun) as the new FY begins, is the highest in FQ2 (Jul-Sep), and then drops to below FQ1 and FQ2 levels in FQ3 (Oct-Dec). FQ4 levels are low too - usually lower than FQ3.

If you think about it, the seasonality makes sense. The government often tends to control spending in the 4th quarter of the FY (Jan-Mar) in order to meet its Fiscal Deficit goal. Spending picks up in the first quarter of the new FY (Apr-Jun) as the government starts to spend after it announces its budget. Spending is the highest in FQ2 (mid-year) as the government pushes to make funds available to meet its deliverables for the year. After this push, spending is relatively lower in FQ3. Finally, FQ4 tends to be muted as fiscal goals have to be kept in mind again.

This seasonality of government expenditure impacts system liquidity across the year. Higher expenditure enhances liquidity, low expenditure tightens it.

The Government has cut spending in recent months to meet its Fiscal Deficit Target (3.9%) which has added to the tightness in Liquidity  

As you can see in the chart below, average daily cash levels with the government have remained high over the last couple months. In February till date, the government has been sitting on an average daily cash balance of ~Rs. 950 Billion, which is high for this time of year. The reason for this high cash level is the holding back of expenditure by the government in order to meet its FY15-16 Fiscal Deficit target of 3.9% of GDP. While the move is laudable, it has added to the liquidity squeeze being felt by the market.

Average Daily Government Cash Balance by month (Rs. Billion). Note that Cash levels mirror the typical seasonality seen in Government Spending. 

Source: RBI MMO Bulletins, Nerdverve estimates

* Figure for Feb-16 represents avg. daily balance till the 11th of Feb.

Recap: In this post we've learnt: 1) where the CG get its money from, 2) what happens when it receives Advance Tax inflows and how that affects liquidity, 3) what the government's seasonal spending pattern is and how that impacts liquidity. When you put the inflows to the government (taxes and other revenue) and the outflows from the government (spending) together, you can estimate the full impact of the government's budgetary operations on system liquidity.