The latest data points relating to India’s fiscal deficit and the current account deficit highlight the growing risk of macroeconomic and financial instability. While the fiscal deficit is reported to have touched 80 per cent of the revised target of 5.3 per cent of GDP for the current fiscal, the current account deficit reached an alarming level of 5.4 per cent of GDP during the second quarter of the fiscal (July-September 2012).

Sometime back, the Finance Minister P. Chidambaram had revised the fiscal deficit target for the year to 5.3 per cent from the budgeted level of 5.1 per cent of GDP. He had stated that the government was on track to meet the revised target, even though it had lowered its official growth forecast to between 5.7 and 5.9 per cent from the budgeted level of 7.6 per cent. The country’s GDP growth slowed to 5.3 per cent during the July-September quarter, and it will not be easy to contain the fiscal deficit for the year at 5.3 per cent of the GDP.

SUBSIDY SPENDING

A greater cause for worry is the uncontrolled growth in government spending on subsidies through increased resort to borrowing. The Central government’s subsidies have increased from 1.43 per cent of GDP in 2007-08 to 2.44 per cent in 2011-12 and borrowings are slated to zoom to Rs.5.13 lakh crore during 2012-13 from Rs.1.27 lakh crore in 2007-08.

The interest burden on government borrowings has gone up from 16.7 per cent of total expenditure in 2007-08 to 21 per cent in 2011-12. More worrisome is the fact that the borrowings are used for populist welfare schemes and not investment, thus adding to inflationary pressures. The government’s developmental spending has declined from 16.6 per cent of the total in 2007-08 to 13.7 per cent in 2012-13 (BE).

What is more, increasing resort to market borrowings by the government has been crowding out private sector investment in the economy, apart from adding to inflationary pressures. According to estimates, capital spending by private firms in the country which had climbed from 10 per cent of GDP in 2003 to 17 per cent by 2008, has now slumped to around 10-12 per cent of GDP.

Also, due to the high cost of domestic borrowings, the corporate sector is increasingly trying to resort to borrowings from external sources. As a result, the country’s external debt has climbed to $ 365 billion. Hence the country’s foreign exchange reserves, which have virtually remained unchanged now, cover only 80 per cent of the external debt. Foreign exchange reserves cover for imports and debt servicing has now fallen to 6.6 months, from 9.1 months in March 2011.

A sharp fall in country’s exports for several months has not only contributed to the prolonged slowdown in industrial production and consequently to the GDP growth, but also to the worsening of the current account deficit. The trade deficit widened to $22.3 billion in the July-September quarter, compared with $ 16.4 billion in the preceding quarter and $ 18.9 billion in the corresponding quarter of the preceding year.

OIL IMPORTS

Despite the depreciation of the Indian rupee, the country’s exports have fallen sharply for a number of reasons -- lack of adequate infrastructure, poor electricity supply, poor supply-chain management and logistics support.

The country’s rising oil import bill, despite the economic slowdown, has also been responsible for the widening of the current account deficit. The country’s oil import bill rose by 11 per cent during April-October 2012, thanks to the steady rise in domestic consumption. At the same time, exports of petroleum products declined by nine per cent over the same period.

To add to the problem, there has been a decline in the domestic output of crude oil, where growth has turned negative since October 2011, thus increasing reliance on imports. Not surprisingly, the runaway current account deficit has been accompanied by a massive rise in fuel subsidies, which are expected to surge to Rs.1.63 lakh crore this fiscal, despite the September decision to raise the diesel price and impose a cap on subsidised LPG cylinders. Hence, the twin deficit dilemma.

Now it is evident that the key to rein in the runaway twin deficits is a gradual phasing out of fuel subsidies.

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