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Photo: Aniruddha Chowdhury/Mint
Photo: Aniruddha Chowdhury/Mint

Deficit vs growth consciousness

The budget ticks the boxes on fiscal, revenue and primary deficit parameters. It has also done better on the revenue deficit target and effective revenue deficit target

Acouple of days ago, I had posted an article in my blog as to how I would evaluate the Indian budget, and the budget delivered by the finance minister on Monday in particular. As I went through the budget speech document (much longer than last year’s) and all the related documents, I found that the budget ticked most of the boxes. Yet, one could not avoid the impression that the budget had failed to provide a vital spark that might have kindled animal spirits in the country.

The budget ticks the boxes on fiscal, revenue and primary deficit parameters. It has done better on the revenue deficit target (2.5% vs 2.8%) and effective revenue deficit target (1.5% vs 2%). Not only that, it projects an accelerated decline in the effective revenue deficit, reaching 0% by 2018-19. So far, so good.

At the same time, the fiscal deficit is coming down more slowly only to 3% of GDP. In other words, the medium-term fiscal policy statement envisages a drastic rebalancing of expenditure towards capital from revenue items. That is optimistic. For example, for 2015-16, the government expected revenue expenditure to go up by 5%. In the revised estimates, it is projected to rise by 6%. Capital expenditure is expected to go up by 14.2%. But, it is now expected to rise only by 12.9%.

The achievement is still a good one but it only highlights the difficulty of achieving an effective revenue deficit of 0% by 2018-19.

Hence, it is just as well that the finance minister signalled a review of the Fiscal Responsibility and Budget Management (FRBM) framework with the completion of a decade under the FRBM rules marked by fiscal irresponsibility on the part of two United Progressive Alliance administrations.

This government inherited a bad fiscal situation. True budget deficit was more than 6% of GDP when it took office. Hence, to achieve a deficit ratio of 3.5% in the current fiscal year is no mean achievement. But, it has paid a price for it. It has achieved a pro-cyclical fiscal consolidation in the face of faltering global growth and two failed monsoons.

When the Central Statistics Office (CSO) told us a few weeks ago that nominal gross domestic product (GDP) growth would be 8.6% for the year ending March 2016, it also revealed that the nominal growth in net indirect taxes (indirect taxes less subsidies) would be close to 30%. That gave us an inkling that the government would not fall too short of its deficit target of 3.9%. In the end, it didn’t.

We can see that in the excise duty collections. Against the actual excise duty receipt of 188,128 crore in 2014-15, the government now expects to collect 283,353 crore in 2015-16. It is now projected to increase to 317,860 crore in the coming fiscal year.

Now, clearly, this is a dampener for economic activity—both for supply and demand. The government did not pass on the oil price windfall to Indian consumers but kept most of it to itself by raising duties on petroleum products. It is no bad thing from an environmental perspective but the price had been paid in terms of economic growth. That is one of the reasons why the nominal GDP growth target of 11.5% assumed in the budget for 2015-16 had turned out to be too high.

The government now has assumed GDP at current prices to grow at a rate of 11% for 2016-17, rising to 12% in 2017-18 and then to 13% in 2018-19. In the current global environment, these are stretch targets. There is a statistical challenge too. The CSO will have to invest time, effort and money in developing a reliable GDP deflator price index for India that reflects the dominance of the services sector instead of using mostly Wholesale Price Index proxies that might be understating nominal GDP growth and, conversely, overstating real GDP growth.

The government seems to be betting on interest rate reduction to drive growth. It has therefore striven to deliver responsible fiscal parameters so that the Reserve Bank of India could cut rates more aggressively. It has also kept an eye on the bond market. Its positive surprises on the revenue and effective revenue deficit and its projection of market borrowing that is less than the revised market borrowing estimate for 2015-16—which, in turn, was less than the original budget estimate—all point to a bet on interest rate stimulus for growth. That is reasonable, but it might turn out to be a bet on the wrong horse.

India’s growth problem is now not so much a problem of higher interest rates. Its corporations are still digesting their previous borrowing binge. Its public sector dominated banking system is capital deficient and unable to lend. On that score, the budget disappoints with its allocation of a meagre 25,000 crore for recapitalizing banks. That works out to less than $4 billion when the total stressed assets (including unrecognized stressed assets) could be close to $200 billion. To be sure, not all of them would turn bad and ultimately irrecoverable. But the difference in magnitude is too stark to suggest that the worst of the problem might be behind us. That is a big risk for the government’s growth assumption and all the revenue calculations that flow from it.

Indeed, the government has announced tax changes that raise more revenue for it by way of indirect taxes than direct taxes. Hence, its fiscal policy continues to remain more restrictive than even the headline numbers would indicate.

Another disappointment is that the government has made a very tentative beginning in removing corporate tax exemptions and lowering the tax rate. The measures announced reflect revenue-consciousness rather than growth consciousness.

Clearly, much thought has gone into making the tax administration more responsive and friendlier. Second, the government has made a small beginning in addressing labour costs borne by employers. However, the amounts envisaged are too small, as of now, to make a big difference.

It is good to see the announcements on the name change from disinvestment to Investment and Public Asset Management and the abolition of the distinction between Plan and Non-plan expenditure. Also welcome is the emphasis on sunset date and outcome review on new schemes.

In the final analysis, it is a thoughtful, prudent and careful budget. But it is hard to avoid the impression that it has been more careful than it needed to be, especially in the critical areas of bank recapitalization and corporate tax reforms.

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