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

 

How Chidambaram has screwed the next govt even before it takes over

P-CHIDAMBARAM
Vivek Kaul
What we don’t achieve ourselves, we expect from others.
This is a statement I have oft used during family conversations in the context of the “unrealistic” expectations parents and grandparents have from their children and grandchildren.
But it is also true for the current Congress party led United Progressive Alliance (UPA) government. After spending much more than it earned for close to six years now, and managing to screw up the Indian economy left, right and centre, the Congress-led UPA government wants the government that takes over after the next Lok Sabha elections scheduled later this year, to cut down on the fiscal deficit.
The fiscal deficit target set for the financial year 2014-15 (i.e. the period between April 2014 and March 2015) is at 4.1 percent of the gross domestic product (GDP). Fiscal deficit is essentially the difference between what a government earns and what it spends expressed as a percentage of GDP.
The Congress led UPA government set a fiscal deficit target of Rs 1,33,287 crore or 2.5% of the GDP in the financial year 2008-09 (i.e. the period between April 2008 and March 2009). The actual number came in at Rs 3,36,992 crore or 6 percent of the GDP. And so started an era of fiscal profligacy.
The fiscal deficit target set for the financial year 2013-2014 (i.e. the period between April 2013 and March 2014) was set at Rs 5,42,499 crore or 4.8% of the GDP. But it is expected to come in at Rs 5,24,539 crore or 4.6% of the GDP.
This is primarily a result of accounting shenanigans as explained earlier and does not reflect the true state of the government accounts.
The fiscal deficit target set by the finance minister P Chidambaram for the next financial year is at Rs 5,28,631 crore or 4.1% of the GDP. Prima facie, the target is unachievable and there are several reasons for the same.
The petroleum subsidy allocated for 2014-15 stands at Rs 63,426.95 crore. In comparison, the petroleum subsidy for 2013-14 has come in at Rs 85,480 crore. This after, Rs 65,000 crore had been allocated towards it, at the beginning of the year.
Even a higher allocation of Rs 85,480 crore is not enough, given that the under-recoveries of the oil marketing companies for the first nine months of the year stand at Rs 1,00,632 crore during the first nine months of 2013-14 (April-December) on the sale of diesel, PDS Kerosene and cooking gas. The interesting bit here is that since 2009-10, the government has never been able to match the petroleum subsidy it allocated originally at the beginning of the year (as can be seen from the following table).

oil subsidies
Take the case of 2012-13, when Rs 43,580 crore was allocated towards petroleum subsidy at the beginning of the year. The actual bill came in at close to Rs 96,880 crore, which was more than double. Given this, it is highly unlikely that Rs 63,426.95 crore will turn out to be enough.
This means greater expenditure for the government, and hence, a higher fiscal deficit, unless of course it balances the expenditure by cutting down asset creating planned expenditure. That is not the best strategy to follow, especially in a scenario of low economic growth which currently prevails.
Interestingly, even after making a higher allocation, a portion of subsidy payments is typically postponed to the next year. Estimates suggest that this year close to Rs 1,23,000 crore of subsidies have been postponed to the next year. The next finance minister would have to meet this expenditure.
If this expenditure has to be made and assuming that everything else stays equal, the fiscal deficit of the government would shoot to Rs 6,51,631 crore (Rs 5,28,631 crore + Rs 1,23,000 crore) or 5.1% of the GDP, against the currently assumed 4.1% of the GDP.
The only way the next finance minister would be able to meet the fiscal deficit target of 4.1% of the GDP, would be by following Chidambaram’s strategy of postponing expenditure, which is not the best way to go about it.
Another interesting point is the allocation of Rs 1,15,000 crore made towards food subsidies. Prima facie this does not seem to be enough to meet the commitments of the Food Security Act.
The government estimates suggest that food security will cost Rs 1,24,723 crore per year. But that is just one estimate. Andy Mukherjee, a columnist with 
Reuters, puts the cost at around $25 billion. The Commission for Agricultural Costs and Prices(CACP) of the Ministry of Agriculture in a research paper titled National Food Security Bill – Challenges and Options puts the cost of the food security scheme over a three year period at Rs 6,82,163 crore. During the first year (which 2014-15 more or less is) the cost to the government has been estimated at Rs 2,41,263 crore.
Economist Surjit Bhalla in a column in 
The Indian Express put the cost of the scheme at Rs 3,14,000 crore or around 3 percent of the gross domestic product (GDP). Ashok Kotwal, Milind Murugkar and Bharat Ramaswami challenge Bhalla’s calculation in a column in The Financial Express and write “the food subsidy bill should…come to around 1.35% of GDP.”
Even at 1.35 percent of the GDP, the cost of the food security scheme comes in at close to Rs 1,73,000 crore (1.35 percent of Rs 12,839,952 crore that Chidambaram has assumed as the GDP for 2014-2015).
All these numbers are more than the allocation of Rs 1,15,000 crore made by Chidambaram towards food subsidies. This means that there will be trouble for the next government in balancing the budget.
Of course, the new government that takes over after the Lok Sabha elections will present a fresh budget, in which it can junk all the calculations of the current budget (or to put it correctly, the vote of account). But even if the next government does that the expenditure commitments that the Congress-led UPA government has created are so huge, that it will be completely screwed on the finance front, even before it takes over.
This article originally appeared on www.FirstBiz.com on February 17, 2014

Vivek Kaul tweets @kaul_vivek