There has been much discussion on the adverse impact of a ballooning fiscal deficit. Higher inflation and crowding out of private investment are some of the problems arising out of fiscal profligacy.
Furthermore, the twin-deficit hypothesis states that the government budget deficit and current account deficit feed on each other. To get back to a high growth path coupled with low and stable inflation, the government would need to reiterate its commitment to credible fiscal consolidation. In this context, the Union Budget scheduled for March 16, is expected to present a revised roadmap and plan of action for reducing the fiscal deficit. The focus should be as much on expenditure reduction, especially unproductive subsidies, as on increasing tax revenue.
The revised fiscal outcome for 2011-12 needs to examined; this includes the factors that have led to fiscal deterioration, and the policy options for credible medium-term fiscal consolidation.
Adverse fiscal outcome
We take into account the April-January 2012 budgetary data released by the Controller General of Accounts (CGA) and assume that the average monthly trend seen thus far will broadly continue. The revised fiscal outcome for 2011-12 in respect of key fiscal variables is set out in the table.
As is evident from the table, the worsening of the revenue and fiscal deficit is because of deceleration in tax and non-tax revenues and non-realisation of disinvestment proceeds.
According to CGA data, there has been a substantial increase in petroleum subsidies, and a severe cutback in the Plan component of both revenue and capital expenditures. The latter has adverse implications for growth.
It could be argued that deterioration in the budgetary performance during 2011-12 was due to a combination of cyclical factors (lower economic growth leading to lower tax collections) and structural factors (rigidities in the economy resulting in inflexibility in expenditure reduction).
However, structural factors have had the upper hand. Non-Plan revenue expenditure (mainly comprising interest payments, defence and subsidies), which was budgeted at around 8.2 per cent of GDP, has been estimated to go up to 8.6 per cent of GDP.
In this context, the non-realisation of disinvestment proceeds, substantially lower realisation of non-tax revenue and significantly higher allocation for petroleum subsidies than the Budget estimates, pose a question mark on the the integrity of the Budget, particularly when it is guided by a fiscal legislation.
Policy options
The fiscal year 2012-13 is expected to be better and bring about decent economic growth with macroeconomic stability. The cyclical correction would thus be addressed in the form of increased revenue receipts. However, the issue of subsidies still remains, and this structural factor needs to be addressed.
In the light of the above observation, the likely revenue deficit to GDP ratio and fiscal deficit to GDP ratio could be around 3 per cent and 4.5 per cent, respectively.
The Medium Term Fiscal Policy (MTFP) projections of the 13th Finance Commission have gone haywire. Their forecast of zero revenue deficit by 2013-14 is nowhere in sight. Going by the trends analysed above and considering an improvement in the economic scenario, the target of zero revenue deficit would be achieved only by 2015-16. It is pertinent to note that for fiscal consolidation to be credible it must be of a considerable scope. What is now needed is “expansionary fiscal contraction” focusing on expenditure prioritising. Narrowing the deficit is in itself expansionary, as it opens the road to private sector-led growth.
Reducing deficits by raising taxes or reducing unproductive government expenditures would free up resources for use by the private sector. However, the progress in achieving the targets prescribed in these rules has been extremely poor.
Revenue deficit predominates and pre-empts capital spending, with adverse growth implications . In the present milieu, a relevant policy option would be to have cutbacks in subsidies, particularly petroleum. This requires further deregulation of the prices of petroleum products. Capital expenditure should be self-financing and self-limiting.
Financing fiscal deficit
At present, there is no rule governing the financing of fiscal deficit, particularly on borrowing from the Reserve Bank of India (RBI). The elimination of ad hoc Treasury Bills and discontinuance of participation of RBI in the primary market were epoch-making steps under the borrowing rules.
However, Ways and Means Advances (WMA) has been used as a key source by the GoI, and not just as funds to meet temporary mismatches. One policy option in this regard is to announce a working group to look into the financing of fiscal deficit with terms of reference extending to usage of small savings, WMA and cash surplus.
The forthcoming Budget is expected to lay out a credible roadmap, setting out a timeframe for reducing the revenue deficit to zero. This would, in turn, reaffirm Budget integrity and give a boost to market confidence.
(The authors are on the faculty of Institute of Management Technology, Hyderabad.)