The trouble dealing with India's deficit

As we proceed closer and closer towards the Union Budget 2010-11 a question that is being commonly asked in the governmental as well as intellectual circles is that of India's bulging fiscal deficit.

The key points being discussed are whether the government will keep on upholding the various "stimulus" measures that it provided to the economy in the aftermath of "The Great Recession" (which to be fair was not so great in the case of India!).

But the question of fiscal deficit is not only being faced by India but rather by the finance ministries of all major and industrialized nations in the world including the US, UK and numerous nations of the Euro Zone.

According to the Finance Minister (FM), Mr. Pranab Mukherjee's own projections he sees India's fiscal deficit at 6.8% by the end of 2009-10. But there are signs already that the fiscal deficit may remain much higher and the FM misses his target. The Central Fiscal Deficit (CFD) stood at a whopping 7.9% in the first half of fiscal 2009-10 as compared to 4.4% for the corresponding period in the previous fiscal year.

The financial ministry is showing indications of curbing this stimulus and gradually removing it altogether in a gradual process but the road does indeed seem very tough and tricky for the FM to meet his target and reduce the deficit.

The key reasons why I believe that reducing the deficit is going to be tough for the FM are listed as follows:

1. Generally the activities for which the government provides various ministries with money take time to start and thus spending picks up gradually, only accelerating in the end of the financial year. Thus we haven't seen the real expenditure happening as of now and will only get a clear picture of the total expenditure towards the end of the FY that is still around 2 months or so away.
2. One of the other major reasons why the deficit won't budge is that the tax revenues of the government will not pick up this time unlike the previous years due to a sharp decrease in tax rates in various avenues, especially indirect taxes like CENVAT (Central Excise). Excise revenues of the government have declined nearly a quarter in the November-January period as compared to the previous year due to a sharp decrease in duty rates even though the industrial production has risen in the same period compared to the corresponding period in the previous year.
3. Direct tax collections have risen only marginally this year.
4. Customs and Service Tax collections are down significantly.
5. The Tax-GDP ratio which is a very important economic indicator has gone from 12% in the April-September period last year to 10.3% in the current fiscal year.
6. The government also has to provide for other expenditures like fuel subsidies, food subsidies, loan waivers to farmers and many other such expenses.
7. The government can't just forgo spending on the initiatives taken by it in the previous years which include many large social sector programs that require a lot of spending.
8. The government also needs to allocate sufficient funds to various ministries and departments in the upcoming fiscal so as to not hinder their working and ensure smooth working of these departments.
9. The 3G spectrum auctions which were earlier slated to be held this fiscal year are more or less likely to be held in the next fiscal (or even in the one after that) due to various bureaucratic hurdles. The auction was supposed to fetch the government anywhere between 30-50 thousand crore rupees which would have been a great help in covering the deficit

Looking at all these things, I think its safe to say that some sort of severe austerity drive and maybe even gradual tax increases are in store for us including monetary tightening by the Reserve Bank of India (RBI) to control credit growth (not to mention control the spiraling inflation).

I don't think the budget will have anything "stellar" in store for us although the government may concentrate on taking measures to ease tariffs and taxes for specific sectors who really do need its support in order to thrive or survive.

One thing is certain. The stimulus measures will go away fairly rapidly restoring the pre-recession tax regime in order for the government to facilitate an increase in its revenues. And anyway, we won't need the stimulus in a few months time as the economy will be almost back to the boom time growth rates.

As Union Finance Secretary Ashok Chawla recently said in a meeting of leading representative body of trade and industry "Too much stimulus when the body is getting healthy may not be a good thing. It can be injurious to health."

Let's wait for 28th February to find out what happens....

Mitul Choksi

4-Feb-2010

11:19 PM Indian Standard Time