Mr Jaitley, what is India’s ‘real’ fiscal deficit?

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The ministry of finance released the Mid-Year Economic Analysis for 2015-2016(April 2015 to March 2016) last week. One of the worrying things that it pointed out in the report was regarding India’s fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.

In the annual budget for 2015-2016, it was projected that the fiscal deficit for the year would work out to Rs 5,55,649 crore or 3.9% of the gross domestic product (GDP). From the way things stand as of now it is highly unlikely that this number will be achieved.

Why is that? It is all about the way the GDP number has been calculated. When the government says that it expects the fiscal deficit to be at 3.9% of the GDP, it is talking about the GDP in nominal terms. Nominal GDP is essentially GDP which hasn’t been adjusted for inflation. The GDP for 2015-2016 has been projected at Rs 14,108,945 crore by assuming an 11.5% growth over the GDP of Rs 12,653,762 crore for 2014-2015 (April 2014 to March 2015).

Hence, the projected fiscal deficit of Rs 5,55,649 crore expressed as a proportion of the projected nominal GDP of Rs 14,108,945 crore is 3.9%. So far so good.
The trouble is that 11.5% growth is turning out to be an extremely optimistic assumption. The Mid-Year Economic Analysis points out that the GDP growth during the first six months of 2015-2016, has been at 8.2% instead of the assumed 11.5%. And this is a huge gap.

If the GDP is to grow by 11.2% during the course of the year, then it needs to grow by 13.6% during the second half of the year. i.e. between October 2015 and March 2016.

The way things stand as of now that seems highly unlikely. So how will the fiscal deficit look if the GDP grows by only 8.2% during the course of the year? In that case, the fiscal deficit will work out to 4.1% of the GDP, assuming that the absolute number of Rs 5,55,649 crore, does not change. Hence, the fiscal deficit will see a jump of 20 basis points from the expected 3.9% to the actual 4.1%. One basis point equals one hundredth of a percentage.

As the Mid-Year Economic Analysis points out: “It is true that the decline in nominal GDP growth relative to the budget assumption will pose a challenge for meeting the fiscal deficit target of 3.9 per cent of GDP. Slower-than-anticipated nominal GDP growth (8.2 percent versus budget estimate of 11.5) will itself raise the deficit target by 0.2 percent of GDP. The anticipated shortfall in disinvestment receipts, owing to adverse market conditions for a portfolio that largely comprises commodity stocks, will add to the challenge.”

So how does the government plan to tackle this challenge? As the Mid-Year Economic Analysis points out: “Tax collections have been buoyant. That plus the additional revenue measures (the Swachh Bharat cess and recent increases in excise) will ensure that central government’s target will be met.”

Last week the government raised the excise duty on petrol and diesel again by Rs 0.30 per litre and Rs 1.17 per litre respectively. This will add Rs 2,500 crore to the government kitty during the remaining part of the year. The total excise duty on petrol and diesel currently stands at Rs 19.36 and Rs 11.83 per litre.

Excise duty on diesel and petrol has been a major source of finance for the government. As Harsh Damodaran writes in The Indian Express: “Since June 2014, the specific excise duty on diesel has been hiked from Rs 3.56 to Rs 11.83 per litre, and from Rs 9.48 to Rs 19.36 per litre for petrol. The annual revenue gain to it from these increases would add up to Rs 95,000 crore or so — Rs 68,000 crore from diesel, and Rs 27,000 crore from petrol.” The excise duty has been hiked seven times since November 2014.

Getting back to the fiscal deficit—it is more than likely that the government will meet the fiscal deficit target of 3.9% of the GDP. This will be achieved through higher excise duty collections. Don’t be surprised if the excise duty on petrol and diesel is increased further, if the price of oil falls any further (let’s say it goes below $30 per barrel). Along with that some expenditure cuts will also have to be made. As the Mid-Year Economic Analysis points out: “If the typical pattern of revenue collection and spending is taken into account, the first half outturn is well in line with meeting the year’s target.”

Nevertheless, it needs to be pointed out here that the government has been postponing the payment of fertilizer as well as food subsidies. As the economist Ashok Gulati writes in The Indian Express: “Fertiliser policy is in a mess. Unpaid fertiliser subsidy bills to the industry have crossed Rs 40,000 crore, and will likely reach Rs 48,000 crore by the end of this fiscal year, as per industry estimates…The finance minister may be smart enough to show that the fiscal deficit is under control, but unpaid fertiliser and food subsidy bills have together already crossed Rs 1,00,000 crore.”

Over and above this, a report in The Financial Express points out that the unpaid subsidy of the Food Corporation of India (FCI) was at an all-time high of Rs 73,650 crore as of March 2015. What this tells us very clearly is that the fiscal deficit number of 3.9% of the GDP is incorrect. It has been achieved by the government postponing the payment of subsidies.

This is not a good practice given that the aim of any accounting should be to put forward the correct financial picture. By postponing the payment of bills, the government beats that very purpose.

It needs to be pointed out here that this isn’t something that the Narendra Modi government started. It was something that they have inherited from the previous Congress led United Progressive Alliance government.

Having said that it is now their problem and it needs to be tackled, instead of just being postponed. As Gulati writes: “Clear the arrears…If not in one go, the finance minister could commit to doing this over two years. Blaming the previous government for the mess will not help.

Indeed, that is a sensible suggestion which the finance minister Arun Jaitley should implement when he presents the next budget in February 2016. Also, a part of the finance for these payments could be raised through shutting of loss making public sector enterprises and selling off their assets (primarily land in cities which is in perennial short supply).

The question is will Jaitley choose to clean up the government accounts or postpone the problem again? My bet is on the latter. How about yours?

The column originally appeared on The Daily Reckoning on December 22, 2015