New Delhi: Signs that India’s ruling coalition is loosening its purse strings to shore up voter support as a political impasse points to an early election could jeopardize a target to reduce the fiscal deficit.
The budget gap has almost halved to 3.5% of the gross domestic product (GDP) in 2006-07 from five years ago as a rapidly growing economy boosted revenues. But an expected hefty pay rise for government workers, plans to keep fuel prices low, and new welfare schemes for the poor—a huge vote bank—could inflate the deficit again.
Analysts say the coalition’s populist tendencies of late included announcing a health insurance scheme for the poor that will cost $190 million (Rs748.6 crore) a year. It widened a rural job guarantee plan, which is now expected to cost $5 billion a year. The government has also made more civil servants eligible for bonus payments. And despite record global oil prices, it has resisted increasing retail petrol prices.
If such populist spending goes unchecked, the fiscal deficit will swell back above 4% of the GDP, analysts say, especially as economic growth is seen slowing from the blistering 9.4% pace in the year to the end of this March—the fastest growth in 18 years.
“Most of the steps taken by the government in the recent past would be negative from a fiscal deficit perspective,” said Harish Menon, an economist with ING Vysya Bank.
“But the think tank is probably counting on a higher GDP base to achieve the fiscal responsibility and budget management targets,” he said, referring to the finance ministry.
The Fiscal Responsibility and Budget Management Act binds the Union government to cut the deficit to 3% of the GDP by 2009, but an early election could mean abandoning prudent economics in favour of populist spending. Slowing growth and higher spending would force the government to rely more on borrowing, which could push up local interest rates. So far, the government bond market has not shown too much concern about the spending plans, focusing instead on the prospects of another increase in bank reserve ratios as the central bank fights an appreciating rupee.
But analysts say market concern about the budget deficit could grow if an early election looks more likely.
The next general election is due in May 2009. While an early election is by no means certain, speculation of one has mounted after nearly two months of deadlock between Prime Minister Manmohan Singh’s government and its Communist allies over the Indo-US nuclear deal.
The fiscal deficit has narrowed in recent years largely because quicker economic growth boosted revenues, rather than owing to spending discipline or reform. Growth has averaged 8.6% over the last four fiscal years. A Reuters poll showed economists expect growth in Asia’s third largest economy to moderate from more than 9% in the last fiscal to 8.5% in 2007-08 and 8% in 2008-09 as tighter monetary policy takes effect.
“Recent decisions suggest that government may be getting into election mode,” said A. Prasanna, economist with ICICI Securities. “Going forward, it is highly probable that the government goes slow on contentious issues and resorts to doses of populism.”
The greatest dent to government coffers is likely to be pay hikes for 3.4 million Union government workers. A government panel, set up once a decade to assess civil servants’ salaries, is expected to propose a hike of up to 30% when it submits its report in April, although the timetable could change. Analysts say other populist measures could include expanding the old-age pensions and introducing death and disability insurance for the poor. Reuters