Column : Boxed in fiscally

Written by Indranil Pan | Updated: Jun 16 2009, 03:30am hrs
Until recently, the fiscal deficit / GDP ratio had gone down over the years and such reductions were broadly in line with FRBM targets. In FY04, this ratio was at 4.5%, moved lower to 3.1% in FY08 and was also expected to be lower at 2.5% in FY09 before the fiscal strings were loosened. But a closer look reveals that the fiscal deficit in the absolute sense has never come down in all these years. In FY04 it was at Rs 1,23,000 crore and this rose to Rs 1,44,000 crore in FY08. Thus, when considered as a proportion to GDP, the sharp correction in the fiscal deficit was possible due to the sharp increase in the GDP growth of above 9% in FY06, FY07 and FY08.

The important issue is that the reliance on managing the fiscal in all these years fell almost entirely on revenue buoyancy, a direct result of high growth. It is true that as part of the reforms process the tax net had been widened and there were attempts to improve compliance. But it is also important to note that gross tax/GDP ratio maintained its upward trend to reach 12.8% in FY08, but immediately fell in the year of slowdown to 11.6% to FY09 and has been estimated to be at around 11% in FY10. The estimates for taxes for FY09 were lowered in the Interim Budget but these also have failed to materialise. This shows the stress on the revenue side and in the final analysis the tax/GDP ratio for FY10 could turn out to be even lower.

For tax revenue generation, there is heavy reliance on corporate taxes, with its share of nearly 35% in the gross tax revenues. Between FY05 and FY08 corporate tax collections grew at 30%, 23%, 43% and 37%. The manufacturing sector, however, grew by only 2.4% in FY09 and the growth in corporation taxes came down to 15%. This is further expected to reduce to 10% in FY10 with a continuation of the slowdown story. On the excise duty side, which is solely related to the prospects of the manufacturing sector, the growth rates in the four-year period starting from FY05 were 9%, 12%, 6% and 5%. When the manufacturing sector growth slumped in FY09, excise tax collections fell by 12% and are expected to grow at only 2% in FY10.

Thus with around 53% of the tax collections significantly hinging on cyclical factors, there is a problem to find adequate revenues to fund higher expenditures. And the tax buoyancy could take some time to return. Relevant also is the fact that even after significant widening of the tax net, the services sector, that is almost 60% of the GDP, contributes less than 2% of tax as a proportion of GDP and only around 10% of the gross tax collections. There are various services to which this tax is still not applicable and previous experience suggest that taxing certain services could also be politically difficult.

The expenditure side presents its own set of problems. Essentially, a large part of government expenditure is non-discretionary. The present governments agenda indicates that the focus continues to be on helping the rural and urban poor. Subsidised food-grain to the poor, providing health cover to the poor and construction of rural homes all form a part of the agenda for the next 5 years, indicating that it could be difficult to bring down social sector expenditures.

However, my real concern comes from the likely bulge that could be experienced in the interest payment burden of the Central government as a result of market borrowings that is around 2 to 2.5 times in size now compared to the normal size in the 4 to 5 years before the crisis year of FY09.

Thus, the burden that the global crisis has inflicted on India through the fiscal side could be large and recurring in the years to come. Renewed efforts at fiscal consolidation will not be possible through containment of the non-plan revenue expenditures. Unfortunately, capital expenditure as a proportion of total expenditure has been declining sharply over the years and this trend could continue, thus hampering the desirable growth in infrastructure investment.

The author is chief economist, Kotak Mahindra Bank. These are his personal views