Fixing the deficit problem

Fixing the deficit problem

With less than a week before the 2011-12 Budget is presented, it is interesting to note the convergence between government and private sector economists on the key risk to the Indian economy today—the fiscal imbalances that afflict the country.

The story, so far, is well known. The 2010-11 Budget had estimated the fiscal deficit at 5.5% of the gross domestic product (GDP). Higher than anticipated nominal GDP growth was one factor, a revenue windfall from one-off items such as money from spectrum auctions and disinvestment proceeds, led to a lower level of fiscal deficit. Estimates by private sector economists put the revised figure at 4.8-4.9% of GDP. But if the 3G auctions and disinvestment proceeds are factored out, the deficit shoots up by 1.6-1.8% of GDP, overshooting even the budgeted estimates. In effect, the so-called fiscal consolidation is due more to a sleight of hand than any real effort to check spending.

Undoing such recklessness will be hard. Here the last word belongs to the Prime Minister’s economic advisory council (PMEAC) that in its Review of the Economy 2010-11 highlighted the challenges in fiscal consolidation. If the government follows the 13th Finance Commission’s road map of fiscal consolidation and brings the fiscal deficit down to 3% of GDP, it has a lot on its hands. The PMEAC notes that “on the whole, in the medium term, the Central government may have to raise additional revenue or reallocate expenditures of about 5 percentage points to GDP and this is going to be a formidable challenge".

This is not a task for one or even two Union budgets. The big question, however, is whether the 2011-12 Budget will even make a beginning in addressing the problem. The PMEAC notes that higher expenditures on food security, higher wages for workers under the Mahatma Gandhi National Rural Employment Guarantee Scheme and the right to education, will require an additional spending of around 3% of GDP. So in effect the government is caught in a pincer movement of antagonistic demands: Higher expenditure will defy fiscal consolidation and the absence of fiscal consolidation will endanger the macroeconomic environment that has supported strong economic growth, until now.

So what should the government do? Rolling back social sector spending to realistic levels may not be possible in one go, but what the government can do is freeze spending to existing levels. Better utilization of these funds (read less corruption) can deliver good results at even current levels of spending.

What should be the Union budget’s priorities: fiscal consolidation or welfare spending? Tell us at