New Delhi: Declining tax revenue and extra spending to stimulate domestic demand and counter a downturn in the economy are forcing a steep increase in the government’s borrowings this fiscal year, threatening to burden the next government with an unenviable fiscal legacy.
The fiscal deficit, which measures the Centre’s gross borrowings, is projected by the government’s economic advisory body at 8% of gross domestic product (GDP). The finance ministry had initially pegged it at 2.5%, excluding oil bonds meant to compensate state-run refiners for selling fuels at below cost, and other, so-called off-balance-sheet items.
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As a result, the next government, which will take charge after general elections due to be held by May, will have limited room to ramp up expenditure without causing structural harm to the economy. Rating agencies have already warned that they would downgrade Asian economies such as India, Vietnam and Malaysia if there was an alarming rise in their debt-to-GDP ratios.
The snapshot of government finances that will be presented in Parliament on Monday with the interim budget isn’t expected to make for a pretty picture.
“The Central government did not perform satisfactorily while the states did. The conviction (towards fiscal reform) was not there from the very beginning,” D.K. Srivastava, director of Madras School of Economics, said.
The United Progressive Alliance (UPA) government has unveiled two fiscal stimulus packages to boost flagging economic growth, which is estimated at 7.1% for the fiscal year to 31 March, the slowest pace in six years.
Tax collections slide
Tax collections contracted by 13% in October, 15% in November and 25% in December over the previous 12 months. According to data on the website of the Controller General of Accounts (CGA), net tax revenue in the third quarter ended December contracted by a little more than one-fifth to Rs1.07 trillion, compared with the same period in 2007-08, as reported by Mint on 7 February.
The Union government’s fiscal deficit (including off-balance-sheet items such as oil bonds) in 2006-07 was 4.4% of GDP. It had pegged the deficit at Rs1.33 trillion for fiscal 2009.
The government does not show subsidies paid out to fertilizer and public sector oil companies in the budget, because it sets them off against bonds due to mature in the future. Experts say that these off-balance-sheet items need to be included in the definition of the fiscal deficit to present an accurate picture of government finances.
The fiscal deficit can be curbed either by raising tax receipts or curbing expenditures.
Tax collections gained unprecedented buoyancy after the economy averaged a growth of 8.92% over the last four years. Since October 2008, the tax revenues have begun to contract, even while expenditure continued to rise.
No subsidy reform
“They (government) were very passive on the expenditure side; they did not undertake subsidy reform (to curb expenditure growth),” Srivastava said.
Subsidies on food, fertilizer and petroleum, among others, make up the third-largest component of the government’s so-called non-Plan expenditure after interest costs and defence spending. In 2007-08, spending on subsidies was 1.5% of GDP, at the same level as the average between 2000 and 2004.
“Subsidies on food, fertilizer and oil have proved to be difficult to reduce, despite various attempts at targeting them better,” Rakesh Mohan, deputy governor of Reserve Bank of India, said in an April 2008 speech.
At the same time, in the last four years, the UPA government utilized the extra buoyancy in tax revenues to fund more social sector spending instead of cleaning its book of the debt overhang. The growth in expenditure on all social services between 2004 and 2007 rose faster than the 14-15% growth in GDP at current prices. Similarly, in economic services, between 2005 and 2007, spending growth outpaced that of nominal GDP.
Fiscal road map
Despite the sticky nature of some of its expenditure, there was consensus among political parties in 2003 to move towards stabilizing the government’s balance sheet by laying out a road map through the Fiscal Responsibility and Budget Management (FRBM) Act, which would ensure a time-bound reduction in its fiscal and revenue deficits.
On 29 February 2008, then finance minister P. Chidambaram announced that the UPA government would not be able to meet the FRBM road map’s target of erasing its revenue deficit by 31 March 2009, on account of a “conscious shift in expenditure in favour of health, education and social sector”.
The only cuts in government spending have come in the form of reduced capital expenditure, declining from an average level of 4.6% of GDP between 1990 and 1995 to 2.6% of GDP in 2007-08.
“Trying to rein (in) fiscal deficit has been at the expense of capital expenditure,” said M Govinda Rao, member of the economic advisory council to the Prime Minister.
However, Rao also said if the Centre’s capital expenditure were to be added to the capital expenditure incurred by all state governments over the past five years, there has been some improvement.
Some relief accrued on account of interest payments following a softening of interest rates. Interest payments, which averaged about 4.6% of GDP between 1995 and 2000, dropped to 3.7% of GDP in 2007-08.
The absolute sums paid out as interest rose from Rs90,249 crore in 1999-00 to the budget estimate of Rs1.9 trillion for 2008-09.
“Interest payments represent the expenditure of past obligations and are independent of current allocative priorities,” according to the December 2007 report on government finances by the Comptroller and Auditor General of India (CAG), the independent watchdog mandated to monitor government accounts.
The legacy of past debt, among other things, restricts government spending on other programmes. According to CAG, by the end of 2007, about 80% of the annual spending by the Union government was being pre-empted either towards making debt repayments or as resource transfers to state governments.
Graphics by Ahmed Raza Khan / Mint