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Is India close to achieving its fiscal deficit target?

By AK Bhattacharya
May 27, 2015 15:00 IST
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Many experts had actually advised the new finance minister to allow the deficit to widen a bit, but Mr Jaitley chose to honour the fiscal deficit number promised by Mr Chidambaram, says AK Bhattacharya.

Nobody should dispute the laudable performance of the Narendra Modi government in sticking to the difficult path of fiscal correction.

The latest Budget numbers for 2014-15, released last week, show that the fiscal deficit at four per cent of the gross domestic product, or GDP, was even lower than the revised figure of 4.1 per cent, presented earlier in the year.

And the early signals for containing the current year's deficit within the target of 3.9 per cent of GDP look encouraging with indirect tax collections going up by 46 per cent in April, the Union Cabinet taking early action in selling government shares in public sector undertakings and the strong likelihood of reduced subsidy bills on account of a lower than budgeted estimate of international crude oil prices.

Yet some questions are likely to be raised on the manner in which last year's fiscal deficit was reduced.

More importantly, doubts about the sustainability of achieving the numbers for the current year would continue to linger even as the government redoubles its efforts on the fiscal consolidation front by taking important decisions in many areas.

It is important to examine how serious these concerns are and how the government could make a success of its fiscal consolidation programme.

Last year's fiscal deficit reduction story has all the elements of high political drama.

While presenting the Budget for 2014-15 in July last, Finance Minister Arun Jaitley had bravely accepted the fiscal deficit target of 4.1 per cent of GDP, set by his predecessor, P Chidambaram, in the interim Budget he had presented in February 2014.

That was before the general elections were held.

Five months later, Mr Jaitley, as the finance minister of a newly elected government, presented the final Budget for 2014-15.

While doing so, he had the option of rejecting the interim Budget target for fiscal deficit as unrealistic and setting a higher figure of around 4.5 per cent of GDP.

Many public finance experts had actually advised the new finance minister to allow the deficit to widen a bit, but Mr Jaitley chose to honour the fiscal deficit number promised by Mr Chidambaram.

Ignoring the pleas for some more expenditure, he argued that setting a higher fiscal deficit number was possible, but doing so would have had adverse implications for the credibility of the Budget numbers put out earlier by the Indian government.

At a time when the Indian markets and the economy were considerably vulnerable to funding flows from foreign institutional investors, playing around with the fiscal deficit numbers could have been risky. Mr Jaitley eschewed politics in favour of fiscal pragmatism.

A little less than eight months later, Mr Jaitley presented the Budget for 2015-16. Much to everybody's relief, the revised fiscal deficit number for 2014-15 was indeed estimated at 4.1 per cent of GDP.

That was on February 28. Three months later, the revised estimates have been further revised, showing the fiscal deficit to be four per cent of GDP. Two uncomfortable questions, however, have arisen.

Why should the deficit figures vary so much in the space of just three months? A further saving of an estimated Rs 12,600 crore or Rs 126 billion speaks poorly of the government's internal financial management.

Two, the manner in which the overall savings helped reduce the deficit showed basic weaknesses in the quality of government spending.

Going by the actual estimates released last week, the total revenues of the government fell to Rs 11.43 lakh crore or Rs 11.43 trillion, down by about Rs 26,500 crore or Rs 265 billion over the revised estimate of Rs 11.68 lakh crore or Rs 11.68 trillion.

Interestingly, tax revenues fell over the revised estimates marginally and it was the fall in non-tax revenues, which was more substantial.

The decline in tax revenues is perhaps due to the slow economic recovery and lower commodity prices.

But what should cause concern to the government more is the fall in non-tax revenues, which clearly points to its failure to price its services remuneratively or even with the aim of recovering the costs incurred on providing them.

For a government that came with the slogan of minimum government and maximum governance, its failure to adequately account for the costs it incurs on providing a host of services to people is too stark to be ignored. Such expenditure reforms need not wait for any legislative changes and are within the administrative powers of the government.

Not having reformed them reflects poorly on the government's commitment to administrative reforms. But a bigger worry has surfaced on the expenditure front.

Both Plan and non-Plan expenditure have fallen over even what was estimated in February. Worse, the percentage of fall in the expenditure under the Plan head was higher than that under the non-Plan category.

Achieving fiscal consolidation with a squeeze on capital expenditure (that is what Plan expenditure largely accounts for) to offset the loss on tax as well as non-tax revenues may produce a more pleasing fiscal deficit number, but it does not bode well for an economy that is in need of an investment-led recovery.

The problem is that this concern is likely to get worse in the current year.

The fiscal deficit for 2015-16 may eventually come down to the targeted level of 3.9 per cent of GDP.

But will that be achieved at the cost of capital expenditure? Will that continue to ride on revenues from sale of government equity in public sector undertakings?

And, finally, will the reduced crude oil prices, in particular, be used by the government to completely dismantle the poorly targeted subsidies regime for petroleum products and fertilisers?

Ultimately, it is the quality of such expenditure reforms that would enhance the real value of a lower fiscal deficit and make the gains from such consolidation more sustainable.

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AK Bhattacharya
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