Fiscal deficit estimates are unconvincing

The Budget was expected to make some credible fiscal correction and lay out a clear roadmap for fiscal consolidation. It is now accepted that fiscal consolidation has suffered a setback. This article looks into the creative accounting in fiscal correction and the setback to monetary-fiscal co-ordination.

The process has been revenue-led, with little expenditure rationalisation (see table) .

Deficit correction has been envisaged through increase in indirect taxes — mainly service tax, and non-tax revenues (primarily through sale of telecom licences). Expenditure cutbacks are expected to come about through reduction of major subsidies. The reliance on indirect taxes has inflationary potential.

There is no evidence of expenditure rationalisation in the Budget, except for the proposed amendment to the introduction of a Medium Term Expenditure Framework. However, the efficacy of such a policy measure (considering that the next Budget will be a pre-election one) seems open to doubt.

Continued Fiscal Slippage

Deficit targets will once again not be met. The year 2012-13, compared with 2011-12, is not expected to see any dramatic changes in economic growth on the domestic or global front. Growth and fiscal outcomes will be similar, except for some improvements on the revenue side (taxation).

To maintain the budgeted deficit numbers, the government will resort to cutbacks in Plan expenditure, leading to reduction in developmental expenditure.

In addition, on account of market uncertainties, disinvestment proceeds may not be fully realised. Keeping in view the past years' experience of sale of telecom licenses, the amount expected to be raised this time around looks over-optimistic. The budgeted fiscal deficit at 5.1 per cent may slip further to 5.5 per cent of GDP.

The golden rule for deficit correction is to eliminate the revenue deficit. The Budget for 2012-13 proposed to amend the Fiscal Responsibility and Budget Management (FRBM) Act by giving statutory recognition to the concept of “Effective Revenue Deficit” (Revenue deficit less grants given to States for creation of capital assets). Paragraph 12-14 (page 20) of Fiscal Policy Strategy Statement justifies the use of Effective Revenue Deficit (ERD).

The 13{+t}{+h} Finance Commission in its report in paragraphs 9.20-9.25 recognised the definitional refinements in respect of revenue deficit and grants for creation of assets as capital grants. However, in paragraph 9.24 (page 130) of its report, it has clearly mentioned that it would be appropriate to continue with the existing classification of expenditure as revenue or capital and that it cannot be disturbed in an ad hoc manner.

Thus, the claim of Budget 2012-13 that zeroing of ERD tantamounts to elimination of revenue deficit is a reflection of creative accounting.

Monetary options reduced

Financing of the fiscal deficit reveals the following. First, during 2011-12, there was higher recourse to short-term borrowings (91,182 and 364 day treasury bills) to the extent of Rs 1,16,084 crore as against the budget estimate of Rs 15,000 crore.

This implies that during 2012-13, there will be greater pressure on the short-term interest rates on account of higher borrowings to repay these treasury bills.

Second, the gross market borrowings during 2012-13 would be around 5.6 per cent of GDP (Rs 5,69,616 crores). Such a high level of market borrowing would put adverse pressure on monetary, liquidity and debt management. Third, even though the budget estimate assumes zero net Ways and Means Advances (WMA) from the RBI, in the event of continuation of tight liquidity conditions, the recourse to WMA is inevitable. This development would further aggravate the problems of monetary management. With such fiscal pressure, there is no manoeuvrability left with the RBI for a policy (repo) rate reduction.

Securities issued against small savings as a financing item of fiscal deficit are budgeted at Rs 1,198 crore, against an outflow of Rs 10,302 crore. This implies that small savings is losing its importance as a financial savings instrument. The National Small Savings Fund (NSSF) is budgeted to have a loss of Rs 7,117 crores in 2012-13 on top of a loss of Rs 6,233 crores in 2011-12 and a loss of Rs 12,706 in 2010-11.

The accrued income has fallen short of expenditure on account of higher interest payments and management costs. This has occurred despite a reduction in agent commissions. The proposed Rajiv Gandhi Equity Savings Scheme with tax incentives would have adverse implication for small savings as the tax exemption would entice savers.

Our FRBM experience for the last 8 years has been in the nature of an unkept promise. Therefore it is appropriate that an Independent Review and Monitoring of the implementation of FRBM process be instituted in the form of a fiscal council. This would add to the integrity and effectiveness of the Budget.