The Union Government has demonstrated fiscal consolidation in the current year, with its fiscal deficit for the first nine months of FY16 printing significantly lower than the level in April-December 2014. Capital expenditure has expanded at a brisk pace, benefitting from the fiscal space created by higher than budgeted growth of its gross tax revenues.
However, factors such as the low growth of personal income tax, muted disinvestment inflows and implementation of the One Rank One Pension Scheme (OROP) scheme for the defence services pose risks to the fiscal math in the last quarter of 2015-16. On the other hand, the five hikes in excise duty on petrol and diesel since November 2015, would boost indirect taxes by an additional around Rs 15,000 crore in Q4FY16. As a result, there is a limited likelihood of slippage relative to the absolute fiscal deficit target of Rs 5.6 lakh crore in the Budget Estimates (BE) for 2015-16. Based on the assumption that nominal GDP for 2015-16 would be Rs 141 lakh crore, the Budget for 2015-16 had pegged the fiscal deficit for the current year at 3.9 per cent of GDP.
However, the advance estimate for nominal GDP for FY16 released by the Central Statistics Office (CSO) is lower at Rs 136 lakh crore. Factoring in this smaller denominator, the Union Government’s fiscal deficit would need to be curtailed by around Rs 26,500 crore as compared to the BE for the current year, to restrict it to 3.9 per cent of GDP. We expect the Government of India (GoI) to make a concerted effort to meet this target.
In the Union Budget for 2015-16, the GoI had committed to paring its fiscal deficit to 3.5 per cent of GDP in 2016-17. Assuming nominal GDP growth of 11.5 per cent in FY17, a fiscal deficit of 3.5 per cent of GDP translates to Rs 5.3 lakh crore, modestly lower than the Rs 5.6 lakh crore pencilled into the BE for 2015-16. However, achieving this target has been made more challenging by the upcoming pay revision for 5.2 million employees and 4.7 million pensioners of the Central Government, based on the Seventh Central Pay Commission’s (SCPC’s) recommendations. In conjunction with the OROP scheme, the GoI estimates its salary and pension bill to rise by Rs 1.1 lakh crore in 2016-17.
Moreover, given the distress faced by the rural economy post two consecutive unfavourable monsoons, enhancing allocations for social sector and agriculture-focused schemes as well as infrastructure projects for rural areas, including rural roads, irrigation etc. may assume greater precedence in the Union Budget for 2016-17.
The anticipated pickup in both real and nominal economic growth in 2016-17 would prop up the tax collections of the GoI. Presuming no arrears, the average annual payout for each employee/pensioner post the implementation of the SCPC’s award is around Rs 1,00,000. While a portion of the augmented post-tax incomes may be saved, the balance would be spent on food and other items, some of which would thereby attract Central indirect levies. A substantial share of these incremental would have to be shared with the State Governments. Nevertheless, ICRA estimates that around 15 per cent of the Rs 1.1 lakh crore rise in the GoI’s salary and pension bill may return as higher net tax collections of the Union Government. Moreover, a hike in the service tax rate to 16 per cent may be implemented as part of the transition to the Goods & Services Tax regime, which would boost collections further.
Our base case scenario for the coming fiscal assumes a decline in the average crude oil price for the Indian basket to $40 per barrel in 2016-17 from $46 per barrel in 2015-16, modest rupee depreciation, and an increase in the consumption of fuels. This entails a step up in the crude oil price from the sub-$30 per barrel witnessed so far in 2016.
In our view, a portion of this uptick in crude oil prices would be passed on to consumers, while the balance may be absorbed by reversing some of the recent excise hikes on petrol and diesel. Therefore, we are not building in incremental excise inflows on account of these fuels in the coming fiscal, relative to the collections in 2015-16.
However, incorporating the savings accruing from lower average crude oil prices, DBT for LPG, the pilot DBT for kerosene and cessation of LPG subsidy for high income households, ICRA expects the BE for 2016-17 for fuel subsidies to be restricted to Rs 23,000-25,000 crore, providing a cushion of Rs 5,000-7,000 crore as compared to 2015-16. We also expect a benefit of around Rs 5000 crore for fertiliser subsidy per year following the revision in the formula for calculating the price of Rasgas LNG from January 1, 2016.
Notwithstanding these savings, a mix of other revenue augmentation and expenditure correction measures would need to be undertaken by the GoI to absorb the costs of the pay revision and simultaneously enhance budgetary outlays for capital spending while avoiding a fiscal slippage. While the recent change in the dividend policy would boost the GoI’s non tax collections, the disinvestment and strategic divestment programme would also need to be pursued aggressively in 2016-17. The GoI may also consider asking some cash-rich PSUs to purchase its stake in other PSUs rather than divesting through the market route.
With implementation of private investment expected to significantly lag the spurt in project announcements, Government spending on infrastructure is likely to remain a critical engine of economic growth, prompting calls for a wider fiscal deficit in 2016-17. We estimate that every 10 basis points of expansion in the fiscal deficit to GDP ratio would allow for extra spending of a relatively limited Rs 15,000 crore. In our view, it may be more appropriate to instead make additional funding available for capital expenditure through extra-budgetary sources such as the National Infrastructure and Investment Fund.
Compounding issues, the fiscal outlook for State Governments is also challenging, with several likely to participate in the UDAY scheme and revise pay and pension scales over the next 1-2 years. The cloudy outlook for the general government fiscal deficit may push up bond yields.
The author is senior economist ICRA Ltd.
Disclaimer: The views expressed here are solely those of the author.