Government finances have lagged private sector finances for the better part of 10 years. Is the situation about to change?
Here’s what happened. Immediately after the slowdown of 1997, both the private sector and the government had their own financial wreckages to deal with. But the corporate sector moved fast towards normalcy, by cutting costs and bringing down debt. Company balance sheets came back to shipshape pretty soon.
In contrast, till a couple of years ago, the mess in government finances was more or less untouched, despite a lot of tall talk on the need for fiscal discipline. The result was that the fiscal deficit remained stubbornly high. The fear was that the persistently high deficit would damage the overall economy and undo all the good work done by companies on the financial front.
Much has changed over the past three years as far as government finances go. The economic boom, which boosted tax revenues, and the fiscal responsibility and budget management (FRBM) legislation, which imposed welcome limits on official profligacy, helped the government slash its deficit. The fiscal deficit of the Union government, as a percentage of GDP, was already down to 3.8% in 2006-07, compared with 6.2% in 2001-02. This year it is budgeted to come down further, to 3.3% of GDP.
In the last week of June, the finance ministry released the tax-and-spend numbers for the first two months of the current financial year. These initial numbers are very encouraging. The fiscal deficit in these two months was 14% lower than what it was during the corresponding months of 2006-07. This was in large part due to buoyant tax revenues, which grew 44% (as against a budgeted 17% for the entire year). It is quite likely that growth in tax revenues will taper off, but the current trends indicate that India is steadily moving towards a less dangerous fiscal balance.
There is still a lot of work to be done. First, the numbers mentioned above are for the Union government alone. The deficits of the state governments should also be added to give a more complete picture. A new research note by Citi says India’s consolidated fiscal deficit (Union plus state) is still a high 6.3% of GDP. Most Asian countries are at far lower levels. Second, the published numbers do not tell us much about the mountains of contingent liabilities that lie hidden out of sight. Both the Union and state governments, for instance, have given implicit and explicit guarantees to bond holders and lenders to various projects. They, too, should be considered in the fiscal numbers. Third, most of the fiscal correction is due to better tax collections. There has been hardly any progress on expenditure control, a fact that could prove to be uncomfortable in a cyclical downturn, when tax revenues may crawl.
But there is little doubt that government finances are in far better shape than they were five years ago. And they continue to improve further. Meanwhile, there are some signs that corporate finances are deteriorating, though not at a pace that worries us right now. Mint reported on Thursday that sales and profit growth of the 50 firms that make up the S&P CNX Nifty stock index decelerated in the January-March quarter. And credit rating agencies have pointed out that Indian companies have started re-leveraging their balance sheets, by borrowing to fund their new investments and their overseas acquisitions.
Improving government finances and deteriorating private sector finances—this is a mirror image of what we have grown accustomed to. This is not necessarily a bad combination right now, because the drop in the fiscal deficit takes pressure off the bond markets and interest rates while the higher leverage in corporate balance sheets shows that companies are ready to take bigger risks than before.
Is the fiscal correction adequate? Write to us at email@example.com