The final budget presented by the Manmohan Singh government offers proof of what many have suspected for long: Public finances are a mess.
The deficit of the Union and state governments is now at a level worse than in 1991, the year India tumbled into an economic crisis and came within a whisker of defaulting on international loans.
Credit rating agencies have already warned that a worsening deficit could force them to downgrade Indian debt and raise international borrowing costs.
The impact on the domestic money markets should not be ignored either. The next government will have to borrow from the banking system to fund the widening deficit. The government is expected to borrow Rs3.3 trillion in the next fiscal year to cover its deficit, compared with the Rs1.3 trillion it had budgeted for the current year (though the eventual borrowing was at least twice that).
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Huge government borrowing from banks does not seem a major problem right now, when the economy is slowing and risk-averse lenders are not too keen to lend to companies. But let us also not forget that money supply growth is slipping, and hence, a spike in government borrowings is likely to push up interest rates and make the yield curve steeper.
That is not good news for companies. And the private sector could be elbowed out when it starts ramping up production and investment later—thus delaying the recovery.
The numbers are eye-popping. The revenue deficit as a proportion of gross domestic product (GDP) for 2008-09 will be nearly 4.4 times what was budgeted for. The fiscal deficit is at least double of what we were told to expect in February 2008, when then finance minister P. Chidambaram presented his budget.
An expected primary surplus has been replaced by a primary deficit. This parameter does not take into account the interest paid on past debt, and is a pretty good lead indicator of whether public finances are improving or deteriorating. And, none of this even considers the off-budget bonds that the government has issued to oil and fertilizer companies instead of cash; these off-budget liabilities could add up to another 5% of GDP.
Never before in India’s fiscal history has there been such a deviation from what has been budgeted for. Take the fiscal deficit for 2008-09: the revised estimate as a percentage of GDP is 3.5 percentage points higher than the budget estimate. This is unmatched since at least 1970-71 (source: Reserve Bank of India Handbook on the Indian Economy).
The second worst slippage was in 1978-79, when the fiscal deficit was 1.55 percentage points higher than its year-ago level. The government has thrown all rules of sensible finance out of the window in its final year—the only one when its financial management skills were actually tested.
What is truly inexplicable and infuriating is that this mess comes after an unprecedented economic boom that sent tax revenues soaring. Strong tax collections allowed the government to throw money at all sorts of politically attractive schemes as well as to put plans for expenditure reforms in cold storage. This was a noxious combination of hubris and myopia.
India now finds itself painted into a corner. The huge deficits will ensure that the next government will not have the space to spend its way out of trouble. Tax revenues are shrinking while spending demands keep rising. A further increase in fiscal deficits could lead to crippling levels of public debt and fears of rising default risks among international investors.
The next government will have an onerous task—support the economy without pushing India into a new economic crisis.
Niranjan Rajadhyaksha is managing editor of Mint. Comments are welcome at email@example.com