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Can the government manage to keep the fiscal deficit on leash?

Can the government manage to keep the fiscal deficit on leash?
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First Published: Tue, Jun 30 2009. 12 30 AM IST

Debt relief: A file photo of a farm loan waiver list displayed in Barsana, UP. The waiver also added to fiscal deficits outstripping estimates. Harikrishna Katragadda / Mint
Debt relief: A file photo of a farm loan waiver list displayed in Barsana, UP. The waiver also added to fiscal deficits outstripping estimates. Harikrishna Katragadda / Mint
Updated: Mon, Jul 06 2009. 04 24 PM IST
The current economic slowdown has seen the Indian government take an active role in trying to jump-start and revive the economy through a series of fiscal initiatives to boost state spending on infrastructure and other demand- and employment-generating projects. This has resulted in a burgeoning fiscal deficit, which stands at almost 11% of gross domestic product (GDP).
Debt relief: A file photo of a farm loan waiver list displayed in Barsana, UP. The waiver also added to fiscal deficits outstripping estimates. Harikrishna Katragadda / Mint
Against this backdrop, fears surrounding the deficit’s medium term non-sustainability has resulted in India’s sovereign rating being revised downwards by several international agencies. The government now faces the tough task of paying off its huge oil import bill and the pressure to maintain—and possibly extend—the breadth of its social programmes in the next few years.
A nation is said to face a fiscal deficit if the government outlay exceeds the revenue at any time. Owing to the disbursement of three stimulus packages between December and February and the waiver of farm loans, the fiscal deficit in India has outstripped estimates and attained the level that we see today.
The size of government debt is a growing concern due to several reasons. First, the rising debt burden would crowd out productive investments because of the government’s (likely) borrowing from the market, thus curtailing fruitful investments in other growing areas.
Secondly, higher debt may in some instances translate to higher rate of default, thus raising the real rate of interest, which would again eventually crowd out private investments.
Finally, as the debt to GDP ratio grows, the faith in the government’s ability and willingness to make necessary fiscal adjustments declines. This has the potential to increase inflationary expectations.
Is India’s fiscal deficit truly unsustainable in the medium term? A deficit is considered sustainable if the government’s accumulated budget surplus over a defined time is enough to pay accumulated debt and interest. In other words, total current and expected future expenses out of interest expressed in terms of present value terms must not exceed the total discounted income stream of the government. It is this approach that lies at the heart of any sustainability analysis.
The government should be particularly mindful of growth to properly manage the financing of the deficit. If India continues to grow at a healthy pace, it will generate surpluses that will add to the revenue of the government.
In this regard, providing tax incentives to some sectors may be worthwhile in the medium term if the loss of tax revenue arising from the incentives is more than outweighed by the increased tax revenues that are likely to be generated from rising incomes in the tertiary sectors. Secondly, all measures to keep inflation under control are critical to preserve a high real growth rate. Since monetizing the deficit—by printing more money—will raise inflationary pressures, the focus should be kept on not financing the deficit through this route.
Thirdly, the government should also take all measures to keep the deficit from growing. For this, it should plug revenue leakages and not adopt wasteful, non-income generating expenditure. It should also tap into newer sources of revenue such as taxing environmental pollution, aggressively penalizing unfair trade practices and ploughing back the black money residing outside India.
It should also refrain from unmindful short-term borrowing and adopt creative measures—such as interest rate futures—to borrow innovatively so that it can lock itself into a lower interest burden. Finally, the government should seriously consider structured disinvestment in public sector undertakings or public-private partnerships in profitable projects to improve revenues.
The government is today faced with the twin objective of spurring economic growth and bringing down the fiscal deficit. While continued stimuli to attain the first objective are crucial, one cannot ignore the consequences of neglecting the latter. The newly elected government has its obligations and promises to fulfil, which will require more spending. However, a good assessment of this public spending, along with a careful implementation of only those expenditures deemed necessary, is a need of the hour.
Clear evidence of prudent spending and fiscal management can be instrumental in creating a climate of public confidence in the government that is required to improve the efficiency of the fiscal management programmes. Public confidence also keeps inflationary pressures and the dangers of printing too much money in check.
Shanto Ghosh and Ipsa Mohanty are with Deloitte in India. Respond to this column at feedback@livemint.com
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First Published: Tue, Jun 30 2009. 12 30 AM IST