RBI governor YV Reddy has obliquely pointed to an issue that may soon become a widely discussed problem: the true nature of the fiscal deficit. India?s fiscal numbers look healthy on paper, at the Centre and also in states. But the targeted fiscal deficit of 2.5% of GDP in 2008-09 is unlikely to be attained for four reasons. First, growth is slowing down and this reduces the denominator. Second, slowing growth means tax revenue will be adversely affected. Third, Budget numbers don?t factor in the 6th Pay Commission. While the payout is contingent on accepted recommendations (DA hikes have been higher than during the 5th Pay Commission), 0.5% of GDP seems plausible. Fourth, the farm debt waiver isn?t completely factored in. Add the prospects of greater populist expenditure after the Karnataka results, and a fiscal deficit of 3.5% in 2008-09 won?t be surprising. Fiscal Responsibility & Budget Management (FRBM) Act targets will be missed not only on the revenue deficit, but also on the fiscal deficit. But the bigger problem is what the fiscal figures don?t say.
The issue is subsidies on petroleum products and fertilisers. The burden of higher global prices hasn?t been passed on. In the long run, this ruins the economics of both these sectors and future generations will bear the costs. In the short run, oil companies have been partly compensated through the issue of special bonds. Whether included in the fiscal deficit or not, the effect of these off-Budget items is no different. Since such special bonds amounted to 0.7% of GDP in 2007-08, one isn?t going to be far wrong if one expects the true fiscal deficit in 2008-09 to be close to 4.5%. Whenever deficits are discussed there?s pedantic quibbling about whether one should or shouldn?t stick to strict definitions. But even after nearly two decades of fairly liberal economic policies, reporting standards remain low. So the true impact of deficits is not revealed. There has been fiscal consolidation since 1991, but recent trends have reversed this. Central and state fiscal deficits combined (especially after states are forced to implement the 6th Pay Commission recommendations and with off-Budget items included) may be inching close to 10%. This is far away from the oft-cited combined deficit figure of around 7%. Fiscal reform must be put back on the agenda.