Expert Zone

Is the fiscal deficit phony?

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The stock market did not respond positively to the budget in spite of the cut in Securities Transaction Tax (STT) and the provision of tax benefits to retail investors for investment in equity because of the trust deficit in budget arithmetic. The fiscal deficit is too high and could also escalate during the year considering that the assumptions on which it is based are not realistic.

In the 2011-12 budget, the fiscal deficit overshot the target by a huge margin. The finance minister had planned for 4.6 percent; it turned out to be 5.9 percent. The budget was messed up by the RBI with its interest policy which brought down growth and therefore tax revenues, and by the government which let expenditure shoot up under political pressures.

More precisely, a third of the increase in fiscal deficit came from the fall in tax revenues, mainly corporation tax, and two-thirds from the increase in subsidies, mainly food. That put the budget in a strait jacket. The finance minister did try to bridge the gap with the increase in service tax and excise duties which, along with a concession in direct taxes, would mop up 414 billion rupees. That was not enough and the finance minister had to have a go at the bulging subsidies.

Currently, subsidies are 2.4 percent of GDP and to that extent inflate the fiscal deficit. The finance minister has therefore resolved that subsidies will be curbed next year. Not all but those on petroleum products and fertilisers which are regressive and together account for about two-thirds of total subsidies. The latter will be chopped down in 2012-13 to 2 percent of GDP.

That is undoubtedly brave on the part of the finance minister who had been rebuffed by the Trinamool Congress for the minor offence of permitting an increase in railway passenger fares. That was also how this critical ally in the UPA had reacted to earlier increases in petroleum prices. Against this background, the initiative of the finance minister to slice off petroleum and fertiliser subsidies seems presumptuous in spite of the assurance by the prime minister that, when the time comes, he would bite the bullet. Probably what he means is that time may not come if international oil prices ease.

Not to be discouraged by the fall in tax revenue in 2011-12, the finance minister has budgeted for a 19 percent increase in tax revenues because he expects the economy to grow at 7.6 percent in 2012-13. Even if it does, the 19 percent increase, excluding additional taxation, in unlikely to come. The experience of 2011-12 is that a 1 percent increase in GDP generates 2 percent increase in tax revenues. On that basis, a shortfall in tax revenues in 2012-13 is not unlikely.

Why the budget is under stress

(The views expressed in this column are the author’s own and do not represent those of Reuters)

In the first seven months, the fiscal deficit crossed three-fourths of the target set for the year. This was entirely because the liberal expenditure on current account was not covered by the revenue the exchequer earned. It is quite on the cards that fiscal deficit for the year will exceed the target.

The fiscal deficit has been a cause of worry for most finance ministers. That is because the budgets they present to parliament are inevitably overcome by political rather than economic considerations. That is what has put many of the governments in Europe on the brink of sovereign default.

Even the U.S. credit rating was downgraded by S&P precisely because the fiscal deficit was excessive. India is no exception.

It is the revenue deficit that has created the problem for Pranab Mukherjee because nearly 86 percent of the current expenditures are on interest payments, defence and subsidies, leaving no room for manoeuvre.

Subsidies are not on par with interest payments and can be the key to fiscal consolidation. In the budget for 2011-12, the finance minister had provided 1.43 trillion rupees for subsidies on fertilisers, food and petroleum products. That was 13 percent less than the expenditure in the previous year. But actual expenditure in the first seven months of the current year was 8 percent higher. The political appeal of subsidies is irresistible. In the last eight years, subsidies quadrupled when total expenditure only trebled.

Are all the subsidies really necessary? Certainly not because most subsidies benefit sections of people that are quite well off.

Fiscal deficit to kick up growth

(The views expressed in this column are the author’s own and do not represent those of Reuters)

In the first quarter of 2012, the government will be over-crowding the financial market to mop up nearly a trillion rupees. It is forced to borrow mainly because the expected revenue did not come in while the expected expenditures had been met.

Last year, the government had spent 55.7 pct of the budgeted expenditure for the year in the first six months. This year, the expenditure was at about the same percentage but the fiscal deficit was 74 pct of the budgeted amount. That was because of the shortfall in receipts. The tax revenue collected in the first half of the year was only 45 pct of expected revenue.

There is anxiety about the bloated deficit. The RBI had repeatedly warned the excess fiscal deficit was pushing up inflation. Besides, the lack of fiscal prudence was infringing FRBM (Fiscal Responsibility and Budget Management) Act which has targeted fiscal deficit at 3 pct of GDP. That target is looking increasingly illusory.

The government can bring down the fiscal deficit only by cutting expenditure. Many of the revenue expenditures like interest payments, defence, etc., and some capital expenditures like loan repayment are committed and cannot be reduced. The only expenditures that can be brought under the axe are subsidies and investment.

A cut in subsidies, though desirable, is politically difficult particularly now because elections in five states will soon be held. On the contrary, subsidies are bound to increase with the introduction of the food security Bill which is already pending in Parliament.

Inevitably, if expenditures have to be cut at all they will have to be in respect of new investment. That happens most of the time resulting in cost and time over-runs. No wonder capital expenditure in the first half of 2011-12 was only 48 pct of the budgeted expenditure for the year while it was 55 pct of revenue expenditure.

Budget FY 2012: A neutral event

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The FY 2012 Union Budget is largely a neutral event:

The Budget provides incentives for increased infrastructure spending along with increased funding sources while highlighting supply side issues in agriculture with an effort to provide solutions.

It also creates an avenue for funding of the current account deficit (albeit still linked to capital markets) and creates a roadmap to rationalize subsidies, moderates expenditure growth and takes another small step towards the implementation of DTC and GST.

From a macro perspective, the budget was largely a neutral event. It did not make a major announcement of acceleration of key reforms. At the same time the government maintained restraint by not making populist announcements, such as immediate plans to please the lower- and middle-income sections of the population, considering there are a few state elections due in the current year.