Fiscal deficit looms large

Finance Minister P. Chidambaram and his team of North Block officials would have to try their very best to contain the fiscal deficit at 5.3 per cent of the gross domestic product by the end of this fiscal. The entrenched slowdown in the economy could stall their efforts.

Another important issue is whether they are prepared for the challenge, given the political crisis that the Union Government finds itself in today and the general elections scheduled for 2014 — assuming that the Government lasts its full term.

FISCAL SLIPPAGE

In its second-quarter review of monetary policy, the apex bank contended that a fiscal slippage was likely this year, in spite of recent measures such as upward revision in diesel prices, restrictions on subsidised LPG and levy of service tax on railway freight and passenger fares. It reckoned “a deviation from the projected fiscal consolidation path,” as the fiscal deficit during the first half of 2012-13 comprised more than two-thirds of the budget estimate for the year as a whole.

On the revenue front too, the growth in indirect tax collections had moderated during the first half, as deceleration in industrial growth and foreign trade had hit collections of excise duties and customs duties, respectively. The only silver lining on the revenue front was the sharp increase in service tax revenues due to a hike in the tax rates as well as the widening of the tax base since July.

Even with respect to non-debt capital receipts, the revenue realisations might not match the confidence of the Finance Ministry, as subsequent events have demonstrated on the ground.

No doubt, the Government recently approved partial disinvestment of its equity holdings in public sector enterprises such as Hindustan Copper, Nalco, SAIL, Rashstriya Ispat Nigam, BHEL, Oil India, MMTC and NDMC. It also assumed a whopping Rs 45,000 crore from the auction of 2G telecom spectrum, which turned out to be a damp squib, with just Rs 9,407 crore coming out of it.

Though the Government attributed the dismal yield to the tepid markets and promised to recover the slated amount through further spectrum auctions before the end of the current fiscal, the market conditions may not materially change from now till the end of the fiscal.

KELKAR PANEL’S VIEW

In this context, it is useful to look at the far-reaching recommendations of the Committee on Roadmap for Fiscal Consolidation, headed by Vijay Kelkar, put in the public domain in September. The report laid out the targets as also the steps for course correction that must be pursued for returning to a fiscally prudent and sustainable course.

The Kelkar Committee centred its prescriptions for fiscal consolidation on three major grounds. First, the economy is in a state of high fiscal stress, with a ‘do-nothing’ course likely to result in a Central Government fiscal deficit of 6.1 per cent in 2012-13 — this could result from a likely shortfall in gross tax revenues of around Rs 60,000 crore and higher than budgeted expenditures on subsidies of about Rs 70,000 crore.

Second, this fiscal stress is also compounding the problem of twin deficits, with the current account deficit at 4.2 per cent of GDP last year and possibly at 4.3 per cent of GDP this year, at a time when the global market and capital flows are exceedingly fragile and where financing of this magnitude is creating huge risks for macroeconomic and external stability.

Third, the gross borrowing requirement, already high, is likely to exceed last year’s level by a large margin (5.8 per cent of GDP vs 5.4 per cent of GDP last year), leading to crowding out of private sector financing for investment.

The panel’s drastic medicine of pruning fuel and food subsidies and rationalising Plan expenditures to bring down the fiscal deficit in three years from an estimated 5.3 per cent to 3 per cent by 2014-15 turned out to be an albatross around the neck of the Government. It shelved the report for “wider discussion by all stakeholders.”

MEDIUM-TERM APPROACH

To address the possible impact of this fiscal laxity on investor sentiment, the Finance Minister lost little time in coming out with a statement at the end of October, asserting his Government’s commitment to stay the fiscal consolidation course. The authorities now would opt for a medium-term fiscal consolidation plan from 2012-13 to 2016-17 — a five-year framework to bring down fiscal deficit from an estimated 5.3 per cent of GDP to 3 per cent.

His premise is that “as fiscal consolidation takes place and investors’ confidence increases, it is expected that the economy will return to the path of high investment, higher growth, lower inflation and long-term sustainability.”

This virtuous cycle of activities, to begin with, must entail how the Government is going to contain its borrowings (fiscal deficit), crowding out investment for productive activities through the banking channel.

The real sectors of the economy are unable to access bank credit, as the policy rate remains stratospherically high. This is despite the fact that the apex bank has periodically freed lendable resources by cutting the cash reserve ratio.

Although the Government has pruned fuel subsidies and unveiled a raft of reform measures such as opening up retail, aviation and insurance industries to greater foreign participation, the expectations so aroused for an investment-led revival proved inadequate. The absence of legislative support is a major impediment.

Chidambaram, with his enormous experience in dealing with economic crises, has his task cut out as he prepares the penultimate budget to the election year 2014. Between appeasing voters to earn brownie points and reining in fiscal deficit, the choice is obvious for the politically correct Finance Minister.

But the victim would once again be fiscal prudence, heightening inter-generational inequities.