In a report titled How Will the New Government Cut the Fiscal Deficit dated June 16, 2014, Chetan Ahya and Upasana Chachra of Morgan Stanley write that “a national fiscal deficit below 5% of GDP would allow real borrowing costs for the private sector to decline meaningfully and encourage private investment.”
Fiscal deficit is the difference between what a government earns and what it spends. The national fiscal deficit includes the deficit run by the central as well as the state governments. In the financial year 2013-2014 (April 1, 2013 to March 31, 2014) this number stood at 7.6% of the GDP.
This number the Morgan Stanley analysts believe should be less than 5% of the GDP. Governments make up for their fiscal deficit through borrowing. A lower fiscal deficit means lower borrowing by the government (s) leaving more money on the table for everyone else to borrow.
Also, with the government borrowing less, the interest rates are likely to come down. Further, businesses are more likely to borrow at lower interest rates and this will encourage investment. Or so goes the story.
If the national fiscal deficit has to come down the onus lies primarily on the central government to cut down on its fiscal deficit. As Ahya and Chachra point out “The state governments’ deficit is closer to the trend line…Hence…the bulk of the reduction in the fiscal deficit needs to be at the central government level.”
The question is how well placed is the central government to cut down on its fiscal deficit? Cutting down on subsidies is one option that is suggested by the analysts. Subsidies stood at 1% of the GDP in mid 1990s and since then have ballooned to 2.3% of the GDP.
The trouble with this argument is that a lot of subsidies are offered by the government under programmes which have been cleared by the Parliament. So these subsidies cannot be suddenly done away with.
What can be cut are the so called “oil subsidies”. The central government taxes oil products and earns revenue in the process. Over the years, a major portion of this revenue has been used to pay oil marketing companies for the “under-recoveries” they suffer on selling diesel, cooking gas and kerosene.
For the year 2012-2013 the central government earned Rs 1,17,422 crore by taxing oil products and oil companies. It paid out Rs 1,00,000 crore in the form of cash assistance to oil marketing companies for their “under-recoveries”. What this basically tells us is that unlike earlier, the government did not gain much from taxing oil. In 2012-2013, the gain was only Rs 17,422 crore.
If the fiscal deficit has to come down, this gain has to go up. This can only happen if oil marketing companies are allowed to increase the price of oil products. The trouble is that given the amount of central and state taxes built into the price of oil, Indians are already paying one of the highest prices in the world for these products.
Also, an increase in the price of these products will add to inflation. For a party whose main election plank was “acche din aane waale hain” this can’t be a good sign. What makes the situation even more difficult is the war in Iraq which has led to a spike in the price of oil. The price for the Indian basket of crude oil stood at $111.25 per barrel on June 18, 2014. It had averaged at $106.72 per barrel for the period between May 29 and June 11, 2014. Hence, in a matter of days, the price has gone up by more than 4% in a matter of days.
If oil marketing companies are allowed to pass on this increase to the end consumer it would lead to higher inflation (including higher food inflation). If they are not it would mean increasing “under-recoveries” for these companies. The government will have to compensate the oil marketing companies for these “under-recoveries” and this in turn would lead to a higher fiscal deficit. Also, it is worth remembering that the war in Iraq might continue and lead to the price of oil shooting up further.
What does not help the cause of the government is the fact that the Congress led UPA government had postponed expenses of greater than Rs 1,00,000 crore to this financial year (this includes food, fertizlier and oil subsidies). This money will have to come from somewhere. Ideally, the government should settle this expenditure during the course of this year and try and start on a clean slate from the next financial year, even if it leads to a higher fiscal deficit.
Another major factor that not many people seem to be talking about is the fact that the recapitalization of public sector banks will need a lot of money in the years to come. The Report of The Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak committee) released in May 2014, estimates that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” That clearly is a lot of money. If the government spreads it over a period four years, it would mean an expense of around Rs 90,000 crore (Rs 3,50,000 crore/4) per year. Where is this money going to come from?
The situation becomes even more difficult given that the situation on the tax revenue front has been very weak. As Ahya and Chachra of Morgan Stanley point out “gross tax revenue has declined from the peak of 11.9% of GDP in F2008 to 10% of GDP in F2014.” The analysts go on to suggest that the government should look to “roll back the excise duty cuts for the automobile industry that were introduced in the interim budget.” But that would mean hitting the automobile industry, which in the recent past has looked like coming out of the doldrums that it has been in for a while. Car sales grew by 3.08% in May 2014.
One way out for the government is to start to look at disinvesting its stake in public sector companies in a very serious way, through the next few years. The disinvestment target in the interim budget presented by P Chidambaram had been set at Rs 56,925 crore. This is clearly not enough. The government needs to aim at much more than this. One way of doing this is to cede managerial control and sell out lock, stock and barrel to the private sector. In that scenario the government is even likely to get a premium above the current market price of the company’s stock. But that is not going to go down well with the employee unions. Further in a lot of companies the government will need a new legislation which will allow it to drop its stake below 50%. This includes nationalized banks as well as Coal India.
Having said that it is not a good practice to finance current expenditure by selling things that one owns. But in the short run that is the only way out for the government.
(Vivek Kaul is a writer. He can be reached at [email protected])