The government’s attempt to lift growth after the financial crisis through an increase in consumption has backfired
As the United Progressive Alliance (UPA) government completes its second term in office, it’s time to take a look at its fiscal performance over the years. In 2004-05, the year in which it came to power, the fiscal deficit was 3.88%, down from 4.48% in the previous year. In 2012-13, even after a lot of tightening, the fiscal deficit was at 4.9%. How did it all go wrong? Isn’t fiscal profligacy by the government responsible? And how much did the government splurge on subsidies?
Let’s take subsidies first. It’s true that subsidies went up from 1.5% of nominal gross domestic product (GDP) in 2004-05 to 2.7% in 2012-13. This increase, however, wasn’t because of the government spending huge amounts on food subsidies for the aam aadmi. Food subsidies in 2004-05 were 0.9% of nominal GDP and they remained at that level in 2012-13. Fertilizer subsidies went up, from 0.5% of GDP in 2004-05 to 0.7% in 2012-13. But what really bloated the subsidy bill was the petroleum subsidy, up from a meagre 0.09% of GDP in 2004-05 to 1% of GDP by 2012-13. Who benefited from the largesse? A recent International Monetary Fund (IMF) working paper says that India’s fuel subsidy helps the rich far more than the poor, with the richest 10% of households receiving seven times more in benefits than the poorest 10%.
In 2007-08, the final year of the boom, expenditure on subsidies as a percentage of nominal GDP was at the same level as in 2004-05. It was only from 2008-09 that it started moving up. Recall that international crude oil prices spiked in 2008 and, after a sharp fall, moved up again. The upshot was a huge increase in the petroleum subsidy. Of course, the government could have passed on the crude price hike. But then, the same IMF paper says that eliminating fuel subsidies, “will have a substantial negative impact on the real incomes of households, estimated to range from 4% for the lowest income groups to 5% for higher income groups". And recall that in 2008-09, the financial crisis had already pushed down GDP.
But, hasn’t the government been spendthrift in other ways? Rather surprisingly, total central government expenditure in the national budget actually went down from 16.8% of nominal GDP in 2004-05 to 15.1% of GDP in 2012-13. Even in 2011-12, when the fiscal deficit was 5.7%, total budgetary expenditure was 15.6% of GDP.
Perhaps we should look to 2009-10, when the fiscal deficit went up to huge 6.5% of GDP? But even in that year, total expenditure was at the same percentage of GDP as in 2004-05. And 2009-10 was the year which bore the full brunt of the Sixth Pay Commission award. It was also the year after the Lehman collapse, when every nation in the world was doing its best to stimulate its economy.
What then was responsible for the rise in the fiscal deficit? Consider revenue receipts. These went up from 10.3% of GDP in 2004-05 to 11.8% in 2007-08, but then went down to 10.2% in 2008-09, the year of the Lehman panic and further to 9.4% of GDP in 2009-10, as a result of the tax sops extended as a fiscal stimulus.
This is clearly seen in gross tax revenues, which were at 10.3% of GDP in 2004-05, went up to 12.9% in 2007-08 and thereafter declined to 10.2% as a result of the tax sops, before improving. Note also that the states’ share of central taxes, which was 2.6% of GDP in 2004-05, went up to 3.1% of GDP in 2012-13, so the centre’s net tax revenue has been affected. Clearly, the tax concessions in the aftermath of the crisis, more than higher expenditure, were responsible for expanding the deficit.
But the quality of expenditure also matters. Capital expenditure as a percentage of GDP fell from 3.8% of GDP in 2004-05 to 1.8% of GDP in 2012-13. Nor can it be said that the financial crisis is responsible. In 2007-08, a boom year, capital expenditure as a percentage of GDP was already lower, at 2.6% of GDP.
Instead of capital expenditure, revenue expenditure was pushed up. But here again, the percentage of revenue expenditure to GDP remained flat till 2007-08, spiked in 2008-09 on account of the Pay Commission award, the waiver of agricultural dues and the tax sops, remained at the same level in 2009-10 and has been slowly coming down since. By 2012-13, revenue expenditure to GDP was higher than in 2004-05, but not by much, simply because overall expenditure as a proportion of GDP has declined.
The numbers show that there are three reasons for the current crisis. One of them is the impact of the stimulus given as a result of the Pay Commission award and the global financial crisis. The second is higher international oil prices, which were not passed on. And the third is the government’s neglect of capital expenditure, which constrained supply. The impact of all this has been a boost to consumption and bottlenecks in supply, which led to higher inflation and a high current account deficit.
The government’s attempt to lift growth after the financial crisis through an increase in consumption has backfired. All that it was able to do was postpone the downturn.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at email@example.com