Our economys slowing momentum, especially the associated job losses, demands that the government should try to provide it a fiscal boost. This means that the governments expenditure is bloated beyond normal limits, with the total expenditures for this FY at around Rs 9,00,953 crore compared to an original Budget number of Rs 7,50,884 crore. As a proportion of GDP, this is around 16.6%, against the original budget estimate of 13.84%. The Budget speech explains, there is a clear need for contra-cyclical policy and it calls for a substantial increase in expenditure in infrastructure development where we have a large gap and in rural development. Consequently, for the fiscal 2009-10 the Budget considers a total expenditure of 15.83% of GDP, with headroom to go higher by 0.5-1.0%.
The challenge is to support such a large expenditure out of fading revenue collections. The Budget exercises of the previous 3 to 4 years had been on the premise of a rising domestic growth and rising foreign exchange reserves. This, along with other policy successes of better tax compliance and wider tax net, had led to a significant surge in the tax revenues, especially in the direct taxes. Thus, budgeting for additional expenditures within the requirements of achieving the FRBM targets were relatively easy.
This remains no longer valid. Backed by an anticipation of robust growth, gross tax revenues were estimated to grow by 17.5% when the Budget for 2008-09 was formulated in end-February 2008. Today, the revised estimate for growth in gross tax revenues stands at 7.3%. The worst affected seems to be income tax collections that were estimated to have grown by almost 17% in 2008-09 but are now likely to rise at a very low pace of 3.6%. On the indirect tax side, significant downturn is likely to be witnessed in the excise tax collections, estimated to have risen by almost 8% but now likely to land up with a shortfall of around Rs 30,000 crore from the Budget estimates. This brings us back to the structural lacuna of the Indian tax raising structure where the reliance for taxes continues to rest on the manufacturing sectors. The services sector in India now accounts for almost 60% of GDP but accounts for only 1.2% of GDP when it comes to its contribution to taxes.
And this structural lacuna will continue to haunt tax raising in the next fiscal. The Budget estimates the gross tax revenue to rise by only around 7.0% (even lower than the 2008-09 revised estimate of 7.3% growth), because manufacturing growth is likely to worsen then.
And raising more taxes from the services sector is unlikely in the current environment, where its only tax rate cuts that will be talked about. With the governments purse strings generously loosened, the fiscal deficit is expected to rise to around 5.5% of GDP in 2009-10, with some likelihood of it racing up to 6.5%.
Are we rapidly arriving at a scary debt-GDP ratio scenario The answer is probably in the affirmative. Back of the envelope calculations indicate that this ratio (Centre plus states) is likely to rise to around 78% in 2008-09 from a Budget estimate of around 73.5%. Further, incorporating the higher borrowings of 2009-10, the debt-GDP ratio, as per my calculations, should rise to above 80% by end-March 2010. In an atmosphere of lower inflows of foreign capital, this implies a limited chance of interest rates (corporate borrowing costs) coming down on a sustained basis, save for RBIs monetary policy push that the market is expecting.
Overall, the fiscal situation appears messy but probably unavoidable. The challenge now lies in the speed with which RBI removes monetary accommodation and the government reverts to fiscal consolidation, as large fiscal deficits and monetisation of deficits are naturally inflationary.
The author is chief economist, Kotak Mahindra Bank. These are his personal views