Sluggish direct tax collection, a likely shortfall in disinvestment proceeds and the recent adoption of a new pension scheme for the armed forces could all add pressure in meeting the government’s fiscal deficit target of 3.9 per cent for fiscal year 2015-16.

The potential burden of these is estimated to be at 0.45 per cent of GDP — even with higher dividend inflows, telecom auction receipts and savings on fuel and fertiliser subsidies that could likely generate 0.27 per cent of additional resources, deficit target may slip by 0.18 per cent of GDP. Faced with these additional costs, the government will likely adhere to its target by reducing expenditure.

A decision to reduce capital expenditure more than recurrent expenditure (similar to the trend observed in recent years) could dampen the government’s efforts to kick-start the investment cycle.

In its FY16 Budget presentation in February 2015, the National Democratic Alliance (NDA) government raised FY16 capital expenditure 0.2 percentage points to 1.7 per cent of GDP. The recent improvement in investment has been primarily driven by government expenditure. Beyond FY16, recurrent expenditure is likely to increase further on two counts.

One, the government will revise public sector pay. An upward revision of 20 per cent could widen the fiscal deficit by 0.20-0.25 per cent of GDP for FY17.

Two, the decision to revise defence pensions could widen the fiscal deficit further by 0.1 per cent of GDP in FY17 and 0.8 per cent in FY18.

Slower revenues The April-July 2015 fiscal deficit at 69.3 per cent of the budgeted estimate (BE) in FY16 was worse than the 61.2 per cent figure for the previous year. The widening resulted from higher government expenditure, especially capital expenditure offsetting an improvement in revenue receipts compared with the previous year.

Our detailed analysis of the first four months’ Budget numbers and recent developments point to five key conclusions for the FY16 fiscal deficit burden.

One, a sharp slowdown in direct tax collection could offset the positive impact of higher indirect collection. Direct tax collection (which accounts for 55 per cent of total tax collection) rose by a mere 0.7 per cent y-o-y during the first four months of FY16, sharply lower than the budgeted 11.7 per cent y-o-y. This was primarily led by a contraction in income tax collection (22 per cent of total taxes), down 4.6 per cent y-o-y (versus budgeted growth of 24.2 per cent y-o-y).

Two, non-tax revenue (including dividends, interest receipts and telecom auction proceeds) could offset lower tax collection.

Three, the government has set a disinvestment target of ₹400 billion and ₹295 billion of strategic sales. We believe FY16 revenue shortfall to be 0.3 per cent of GDP. Four, the government budget for fuel and fertiliser subsidies of ₹300 billion and ₹730 billion, respectively, was on a crude oil-price assumption of $70/bbl. However, with depressed crude oil prices the loss incurred is likely to be ₹280 billion in FY16.

Five, new defence pension scheme (OROP) to increase recurrent expenditure by 0.06 per cent of GDP.

This will coincide with a rise in recurrent expenditure as the government implements the recommendations of the Seventh Pay Commission.

The government has already proposed reallocation/reduction of expenditure worth ₹250 billion in FY16 to accommodate higher bank recapitalisation. It may have to reduce capex or raise revenue to meet the fiscal deficit target.

We believe the government may likely adhere to its FY16 fiscal deficit target, despite the likely pressure equivalent to 0.18 per cent of GDP.

The next two years’ budgets will face additional pressure. We believe these potential additional costs, along with fiscal deficit targets of 3.5 per cent of GDP in FY17 and 3 per cent in FY18, should be monitored closely.

(The writer is Head, South Asia Economic Research (India) Standard Chartered Bank, India)

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