Vivek Kaul
The finance minister P Chidambaram has reiterated time and again that the government will adhere to the fiscal deficit target of Rs 5,42,499 crore or 4.8% of the GDP(gross domestic product) that it has set for itself. On September 5, 2013, he had said that the fiscal deficit target of 4.8% of GDP was a “red line and the red line will not be crossed.” Fiscal deficit is the difference between what a government earns and what it spends.
But the latest data released by the Controller General of Accounts (CGA) on September 30, 2013, shows that fiscal deficit has already reached 74.6%(or Rs 4,04,651 crore of the targeted Rs 5,42,499 crore) of the full year target, as on August 31, 2013. Hence, three fourth of the fiscal deficit target has been reached during the first five months of the financial year (i.e. the period between April 1, 2013 and August 31, 2013).
Now how does the situation look in comparison to the past data? For a period of 16 years since 1998-1999 (for which the data is publicly available on the CGA website), the average fiscal deficit for the first five months of the financial year stands at 54.2% of the annual target.
During the period of the Congress led UPA government has been in power (i.e. Since 2004-2005), the average fiscal deficit for the first five months of the financial year has been 60.4% of the annual target. Last year it was 65.7% of the annual target.
In fact, only in 2008-2009 was the number greater than this year. As on August 31, 2008, the fiscal deficit for the first five months of the financial year had already reached 87.7% of the annual target. This was the year when the Congress led UPA government was getting ready for the Lok Sabha elections which happened in April-May 2009, and hence, had gone overboard on the spending front.
The fiscal deficit in 2008-2009 was estimated to be at Rs 1,33,287 crore or 2.5% of the GDP. It finally came in at Rs 3,36,992 crore or 6% of the GDP. The point being that when the Lok Sabha elections are scheduled to happen next year, the initial estimates of the fiscal deficit can be way off the mark. Lok Sabha elections are due in May 2014 as well. Before that there are several state assembly elections as well. So, it remains to be seen whether the Congress led UPA government sticks to the fiscal deficit target of 4.8% of the GDP or goes overboard with the expenditure as it did last time when the elections were due.
What also does not help the government is a slowdown in tax revenues. As Sonal Varma of Nomura points out in a note dated September 30, 2013, “Fiscal year to date (FYTD), net tax revenue growth was muted at 4.9% year on year (versus the budget target of 19.3% year on year) due to weak indirect tax collections (excise, services, customs), while government expenditure rose 17.3% year on year FYTD, within the budget target of 18.2% year on year.”
When the revenue is growing at around one fourth of the expected rate, meeting the revenue target will be very difficult. Expenditure on the other hand continues to rise more or less at the rate assumed in the annual budget.
Given this, the government will have to make a significantly greater effort to control its expenditure, if it has to get anywhere close to meeting its fiscal deficit target. As Varma puts it “In our view, the government will have to announce another round of spending cuts to offset the fiscal slippage from slowing revenue collections and to meet its financial year 2013-2014 budgeted fiscal deficit target of 4.8% of GDP.”
The government had announced some measures to cut expenditure on September 18, 2013. A mandatory cut of 10% in non plan expenditure of all departments was announced. This did not include expenditure on interest and debt repayment, defence capital, salary, pension and grants to states. Over and above this, restrictions have been put on holding seminars/conferences as well as air travel. These measures will not be enough and more expenditure cuts will have to be put in place. In fact, when the government was in a similar but slightly better scenario last year, it simply froze spending, during the last few months of the year.
As Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley, said in a recent interview to the Forbes India magazine “We achieved the [fiscal deficit] target last year, but you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that…So can the government meet its fiscal deficit target? Of course it can. But the price in this case will be economic growth.”
Varma had written along similar lines in a note titled Government Announces Austerity Measures and dated September 18, 2013. As she wrote “The spending cuts will adversely impact growth. High government spending was one of the main drivers of real GDP growth of 4.4% year on year in Q2 2013. With spending likely to be slashed and financial conditions much tighter starting July, we expect private demand to slow down further.” And this will impact economic growth.
The other option before the government is to raise diesel prices. The under-recovery on diesel being sold by oil marketing companies(OMCs) for the fortnight starting October 1, 2013 is at Rs 10.51 litre. In the previous fortnight the under-recovery on diesel stood at Rs 14.50 litre. This fall has been primarily on account of the rupee rallying against the dollar, leading to the price of oil falling in rupee terms. Despite the fall, at Rs 10.51 per litre, the under-recovery on diesel continues to be substantially high.
The government compensates the oil marketing companies for a part of this under-recovery and this means higher expenditure for the government. The oil producing companies like ONGC and Oil India Ltd, compensate the oil marketing companies for the remaining part of the under-recovery.
If the government has to meet its fiscal deficit target it needs to bring down the under-recovery on diesel. And this can only be done by raising diesel prices significantly. Currently, the oil marketing companies increase the price of diesel by 50 paisa every month, which is clearly not enough, given that the under-recovery is greater than Rs 10 per litre.
As Sharma put it “The government will have to raise diesel prices. Currently, they are Rs 9-10 behind on under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target.”
Other than diesel, there are significant under-recoveries on cooking gas as well as kerosene. The under-recovery on cooking gas for the week starting October 1, 2013, stands at Rs 532.86 per cylinder whereas the under-recovery on kerosene is at Rs 38.32 per litre.
The government is essentially in a situation where it has to decide between either meeting the fiscal deficit target or sacrificing economic growth. If it looks like that the government will be unable to meet its fiscal deficit target then India is likely to be downgraded by rating agencies.
A sovereign downgrade will see India’s rating being reduced to ‘junk’ status. This would lead to many foreign investors like pension funds having to sell out of the Indian stock market as well as the bond market, given that they are not allowed to invest in countries which have a “junk” status.
When they sell out, they will will be paid in rupees. In order to repatriate this money, they will have to sell rupees and buy dollars. This will increase the demand for dollars and put further pressure on the rupee, in the process undoing all the damage control carried out by the RBI to prevent the rupee from falling.
A weaker rupee will mean that our oil import bill will shoot up further. We will also have to pay more for the import of coal, fertilizer etc. This will put further pressure on the fiscal deficit as the government expenditure will increase given that it currently offers subsidies on oil as well as fertilizer.
To conclude, in order to meet its fiscal deficit target the government will have to raise diesel prices and at the same time cut its expenditure dramatically, which will have an impact on economic growth. As things currently stand, it looks like the government will have to sacrifice economic growth on the altar of the fiscal deficit.
If the government does not meet its fiscal deficit target then the repercussions of that will also have a huge impact on economic growth. Hence, the choice is between the devil and the deep sea. As Franklin Roosevelt, the President of America between 1933 and 1945, put it “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.” The Congress led UPA government has been running high fiscal deficits for way too long and the negative consequences of that have started to catch up.
The article originally appeared on www.firstpost.com on October 2, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)