New Delhi: The Indian economy is poised on two fault lines that could engulf it if the cracks widen any further. However, some economists say the situation will likely ease in the months ahead because the decline in international crude oil prices will cut the government’s subsidy tab and reduce the country’s oil import bill.
India’s fiscal deficit and current account deficit, which help gauge the health of government finances, are at their highest levels since the 1991 economic crisis. The combined fiscal deficit of the Union and state governments may range between 9% and 12% of the gross domestic product (GDP) in 2008-09, compared with an average of 8.9% of GDP between 1985 and 1990. The fiscal deficit is a measure of the imbalance in government finances that’s filled by borrowings.
The current account deficit for the first half ended September, the latest period for which data is available, was 3.8% of GDP, compared with 3.1% of GDP in 1990-91. It’s the broadest metric to measure the gap between how much a country buys from the rest of the world and how much it sells.
Few other countries have such wide gaps in their national accounts. A global recession that’s causing demand for exports to sag and slowing domestic economic growth may aggravate the problems. The government estimates GDP growth will ease to 7-7.5% this fiscal after averaging 8.9% over the last four years. “There is a bit of a structural problem and global (economic) slowdown is going to add to this problem,” said M. Govinda Rao, a member of the prime minister’s economic advisory council.
The economic slowdown is likely to dent tax collection, putting more pressure on the government’s balance sheet. Data for direct tax collection, which have been the mainstay of government revenue, have not yet been released for the April-December period, but experts suspect growth has slowed significantly.
The spike in global oil prices in the middle of 2008 was the single biggest reason why these two closely watched deficits widened. The government did not push through matching increases in the prices of petrol, diesel and fertilizers sold to domestic consumers.
In fact, higher fuel and fertilizer subsidies have ensured that the government will most likely fail to meet the fiscal deficit target it has set for itself in the budget as well as break a commitment made under a federal agreement to limit its deficits. Meanwhile, a jump in the oil import bill pushed up the current account deficit.
“Balance of payments will come under significant pressure,” Rao said. Unlike 1991, the situation was not alarming, he added. “We don’t have a crisis, (foreign exchange) reserves will bail us out.”
The Reserve Bank of India’s foreign exchange reserves, that touched $304.9 billion (Rs14 trillion) in May at their peak were at $254.8 billion on 9 January. Mint could not independently establish to what extent dollar sales by the central bank were responsible for the fall in foreign exchange reserves and to what extent the depreciation of the rupee against the dollar was a factor. Despite the recent decline in reserves, the size of the hoard reassures foreign investors and has not led to capital flight out of India.
Most economists Mint spoke to maintain that while the magnitude of the twin deficits is worrying, the circumstances are different from those in 1991. The situation will improve later this year, they say.
“There is a global structural adjustment taking place, particularly in the context of the US economy. That will have a structural impact on India,” D.K. Srivastava, director of Madras School of Economics, said of the economy’s biggest structural challenge.
The US government’s measures to combat the crises in its financial sector and the real economy through policies such as pushing benchmark interest rates close to zero would have a far-reaching impact on India, Srivastava said.
The common measure of globalization (total trade as a proportion of GDP) for the country rose from 21.1% in 1997-98 to 34.7% in 2007-08.
According to Subir Gokarn, chief economist, Asia Pacific, with the credit rating agency Standard and Poor’s, the current account deficit spurt is partly due to the sharp jump in the international price of crude which pushed up the value of oil imports.
The average price of the Indian basket of crude—or the varieties of crude oil that India usually buys—between April and September 2007 was $69.1 a barrel as compared with an average price of $116.6 a barrel for the same period in 2008.
Since then, global oil prices have slumped and as they are not expected to bounce back in the rest of the year, the pressure on the external sector will ease, said Gokarn.
Saumitra Chaudhuri, another member of the prime minister’s economic advisory council, said the projected surge in the fiscal deficit, well above the budgeted 2008-09 target of 2.5% of GDP, was largely on account of the oil and fertilizer bonds that the government had issued to make up for the rise in fertilizer and petroleum subsidies because of high international oil prices. The combined deficit at all levels of government this fiscal could be 10%, he added.
The administered price of retail petro products was held steady despite the increase in the price of international crude in the first half of 2008. “The episode has pointed to weakness in fiscal management process,” Gokarn said.
According to Shubhadha Rao, chief economist at Yes Bank Ltd, the softening of commodity prices is likely to limit the increase in fiscal and current account deficits in the next financial year.
However, a person familiar with government finances, who did not want to be identified, said the burgeoning fiscal deficit was beginning to impact the external sector by pushing up the current account deficit. “The problem is apparent and it is time to be watchful,” the person said.
But the economic slowdown complicates matters. The government has been forced to announce extra spending plans to boost domestic demand even as weak corporate profit growth is likely to harm tax collections. Higher spending and lower than expected revenues are likely to further widen the fiscal deficit in the months ahead.