Home >Markets >Mark To Market >An ugly fiscal deficit is a reality, government should make it count

India’s fiscal deficit would look ugly in the current year but how much of this ugliness is just math is an important consideration for policymakers and even rating agencies.

That is because the optical discomfort on the number should be looked through given that it is purely an outcome of the pandemic.

The covid-19 pandemic resulted in a 55-day lockdown which has now been extended further to two more weeks. During the lockdown, there was no economic activity beyond the essentials in most parts of the country. To be sure, the latest two extensions in the lockdown was accompanied by relaxations. Therefore, economic activity has resumed in tranches but is yet to reach the level seen in normal times.

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On the rack

Gross domestic product (GDP) on a nominal basis is expected to be hit. According to Goldman Sachs, inflation adjusted real GDP growth is expected to contract by 5% for India in FY21. The Reserve Bank of India (RBI) believes inflation could slip significantly below 4% target by end of FY21. If one takes the 2.5% forecast given by Ravindra Dholakia, a member of the monetary policy committee, GDP growth on a nominal basis would contract by 2.5%.

Note that nominal GDP is the denominator for all fiscal calculations including fiscal deficit. Economists are now pegging the fiscal deficit of the central government at 5-6%. Those at Nomura have pointed out that much of this deficit is simply because of a collapse in nominal GDP and by extension tax revenues. “By our estimate, the central fiscal deficit target was already slipping from 3.5% of GDP to 6.3% of GDP, purely due to the combined impact of lower nominal growth and weak revenues," the Nomura note said.

Then comes the economic package of nearly 21 trillion announced by the government. As such, the package relies largely on leveraging on existing monies rather than infusing cash. Ergo, the fiscal impact of the package is expected to be a fraction of its size. Economists at Nomura and Goldman Sachs calculate the impact at 0.8% while Barclays puts it at 0.75% of GDP. In short, the government’s finances were stretched even before the pandemic and the lockdown inflicted a deep wound on the balance sheet. The space for economic stimulus was low. The government should be held accountable for poor finances before the pandemic and bond markets have already punished with yields rising. That said, the reality is the economy needs public spending and the only way it can be done is to look past ugly fiscal deficits. Considering the slack in the economy, inflation implications from the worsening fiscal deficit are minimal. For rating agencies, a clear path towards consolidation beyond the lockdown would prompt them to ignore present pain.

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