Controlled expenditure and buoyant tax collections have put the government on a comfortable course to attaining its targets with regard to fiscal and revenue deficits in 2006-07.
The government is required under the Fiscal Responsibility and Budget Management Act to bring down the fiscal deficit to 3% and revenue deficit to zero by 2009. Any deviation from the targets has to be approved by Parliament.
Finance minister P. Chidambaram had paused the fiscal correction spelt out under the FRBM in 2005-06 on account of the recommendations of the twelfth finance commission, which had awarded higher share of the Centre’s resources to the states.
The fiscal deficit, which had increased marginally to 4.3% of the gross domestic product in 2005-06, is expected to be lower at 3.8% in 2006-07. Similarly, the revenue deficit is expected to decline from 2.7% in 2005-06 to 2.1% in 2006-07.
While in many countries the fiscal adjustment process has been achieved through expenditure compression, the fiscal correction in the country since 2003-04 has been achieved on the strength of higher revenues.
The tax revenue as a percentage of GDP has increased to 10.3% in 2005-06 from 9.8% in 2004-05.
This has been showing a growing trend since 2001-02 when it was 8.2%.
The Survey pointed out that expenditure management remained an unfinished task. The implication is that “considerable downside risks remain from potential pressures on the expenditure front,” it warned.
Of the taxes, the share of direct tax as a percentage of GDP has increased from 3% in 2001-02 to 4.5% in 2005-06. Since the mid-1980s, the share of direct taxes has slowly been increasing compared with indirect taxes.
Direct taxes are considered more equitable since the tax is imposed in accordance with one’s ability to pay. Growth in indirect taxes has been more inconsistent on account of the poor performance of excise collections. Indirect taxes were 5.1% of GDP in 2001-02 which increased to 5.5% in 2004-05 and fell marginally to 5.4% in 2005-06.
The Economic Survey, 2005-06 had pointed out that it was critical to raise the tax-GDP ratio to 13% by 2008-09 and shift expenditure into creation of productive assets in order to achieve the FRBM targets.
While the government is squeezing the non-plan expenditure which includes spending in interest payments, wages and salaries, its share as a percentage of GDP continues to be much higher than plan expenditure.
As a percentage of GDP, plan expenditure has declined from 4.2% in 2004-05 to 4.1% in 2005-06. Non-plan expenditure, on the other hand, has declined from 11.7% in 2004-05 to 10.5 % in 2005-06.
About 86% of the revenue receipts in 2005-06 were used on committed expenditure such as interest payments, subsidies, pay, pension and defence.
There are also other pressure points for the government. Though the government is cutting down on its borrowings, with interest rates expected to harden, the average cost of borrowing for the government could come under pressure in future.
Interest payments as a percentage of GDP have declined to 3.8% in 2005-06 from 4.1% in 2004-05. Cost of borrowings dropped to 7.9% in 2005-06 from 10.2% in 2000-01.
Reviewing the performance of states shows that while the fiscal and revenue deficit positions as a percentage of gross domestic product are improving, the causative factors of fiscal deterioration, such as growing burden of interest payments, pension liabilities, losses of state public sector units, lack of proper user charges and lack of buoyancy in tax rates need to be addressed.
The gross fiscal deficit of states as a percentage of GDP has declined to 3.1% from 4% in 2004-05, while revenue deficit declined to 0.7% from 1.4% in the same period.