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India's Fiscal Deficit: The Widening Gap

| 9/26/2011 2:37 PM Monday

One of the reasons why Western economies are in the doldrums today is their unsustainable and high fiscal deficit, which, in simple words, is the widening gap between the government’s expenditure over its income. But is it just the western world that suffers from this malaise? Certainly not. In fact, the situation is no different for the Indian economy too. For FY12, the government has set an ambitious target of bringing down the fiscal deficit to 4.6 per cent of the GDP from 5.1 per cent in FY11. However, in view of the current situation, we believe that it may miss the target in rupee terms once again. If this is so, where will the fiscal deficit stand? Here is an objective analysis of the problem at hand, which should take up a lot of effort of the governmental machinery in the coming months before this fiscal nears an end.

There are three ways by which the government can bridge the gap of a higher fiscal deficit. These are through domestic borrowings, external borrowings or by printing money. However, each of these methods has several drawbacks. For instance, excessive domestic borrowing can exert an upward pressure on the interest rates, while external borrowing may result in an external debt crisis. Printing money would invariably lead to higher inflation. Moreover, food inflation is already running high and is close to the double digit mark, and printing money will accentuate this problem.

The total expenditure that has been estimated in the budget of 2011-12 stands at Rs 1257729 crore, against total receipts of Rs 844912 crore. Therefore, the fiscal deficit comes out to be Rs 412817 crore or 4.6 per cent of the GDP, which itself stands at Rs 8974283 crore. The three components that make for the Rs 844912 crore of total receipts include tax and non-tax receipts, recovery of loans and disinvestment proceeds. Amounts of Rs 789892 crore, Rs 15020 crore and Rs 40000 crore are to be garnered under each of these heads respectively. Of the total estimated receipts, 93 per cent are likely to come from tax and non-tax revenues, five per cent from disinvestments and the rest from recovery of loans. In Q1 FY12, the government has been able to achieve only 11.67 per cent of the total receipts targeted for FY12, against a long-term average of 12.5 per cent.

Let us take a look at each of the components one by one, so that a meaningful analysis of the problem at hand can emerge. First, recovery of loans is on track. 47 per cent of the budget estimates have already been recovered, and the remaining is likely to be achieved as targeted. Now, take a look at disinvestments. On this front, the government has been able to garner just Rs 1145 crore up to Q1 FY12, which is a minuscule 2.86 per cent of the set target. Even the follow on public issue of ONGC has been deferred, raising further concerns on whether the government will be able to meet the target. Lastly, some clouds are hovering over the set target of tax receipts, which account for a lion’s share of the receipts. In the first quarter of the current fiscal, we have seen that profit growth of India Inc. was in single digits, and experts are of the opinion that the bottomline may dip further, which may cast a shadow on achieving the set goals as far as tax receipts are concerned. This is primarily because almost 71 per cent of tax receipts come from corporate taxes. Therefore, the trend suggests that the government is most likely to miss out on the target set on the fiscal front in this year. Now, the question is, if it misses its targets, where will the fiscal deficit go?

To arrive at the fiscal deficit figure, we have adjusted the tax receipts to be lower by nine per cent, which is in line with the revised GDP estimate of 8.2 per cent. As against Rs 789892 crore of tax receipts that was budgeted, we have arrived at a figure of Rs 730829 crore after lowering it by nine per cent, adjusting for the drop in GDP growth estimated by the PMEAC. If we look at the amount collected through disinvestment, we feel that it will cross Rs 25000 crore given the current capital market scenario, which is not conducive to raising money. The only area where the government is expected to achieve its target is in recovery of loans, but that forms a mere two percent of the total receipts. Hence, according to us, in the current scenario, where we do not see any windfall gains for the government as in the last fiscal (the auction of 3G and BWA), the government will, in all probability, miss the target. Moreover, the finance minister had only budgeted for three per cent rise in expenditure for FY12. Thus, the government is left with very few options to curb the expenditure, as it may hurt growth going forward, especially in planned expenditure. Therefore, we have assumed the expenditure to be constant for FY12. According to us, the fiscal deficit will be nearly Rs 500000 crore, which will be more than five percent of the GDP.
This means that on one hand the GDP growth is anyway going to be lower, and on the other, the fiscal deficit will be higher than what was earlier predicted on that lower base too. So, what are the government’s options and their implications? Any slippage on the fiscal gap target is expected to force the government to resort to higher market borrowing and the ‘crowding out’ of private borrowers. For FY12, the government has budgeted a gross borrowing of Rs 4.17 trillion rupees. Of this, it has already borrowed Rs 2.5 trillion between April and September, which is close to 60 per cent of the set targets. It will decide on its borrowing schedule for the second half of the financial year in the beginning of October, 2011.

The calculations at the time of the budget were based on a low subsidy bill, high economic growth and higher proceeds from stake sales in state-run firms. However, a slowdown in the domestic economy, high global crude prices and mounting global economic uncertainty amidst a prolonged Euro zone crisis that has roiled global markets, appear to have upset those calculations. All this does not look encouraging for the economy as a whole, but it certainly pays to know about the coming pains in advance and be pre-pared, rather than be caught unawares going forward.

 

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