At first glance, the fiscal performance of the central government for the first nine months (April-December 2002-03) looks good. The fiscal deficit was Rs 2,745 crore less than that for the same period last year. But an overly bright picture will be misconstrued.

Growth in tax receipts (net to Centre) was up 22 per cent in the first nine months of this year. That sounds great, except that with respect to the Budget expectations, it still represents a shortfall. In the first quarter (April-June) of 2002-03, tax growth was 44 per cent; in the second it fell to 18 per cent; and in the third to 16 per cent. On the basis of quarter-on-quarter growth, estimates of likely tax revenues for the full year, assuming 18 per cent growth in the fourth quarter, indicate a shortfall of Rs 12,000 crore. On the expenditure side, the estimate has extrapolated from the April-December changes over the previous year, although capital items might show bunching in the last quarter.

The estimated variations for key items are in the accompanying table. The large revenue shortfall is likely to be neatly offset by the big saving from interest rate reduction and some economy in non-interest revex (revenue expenditure). Capital items have been cut sharply in the first nine months. Direct capex (capital expenditure) is likely to be significantly lower for the full year. Although gross loans might be higher than budgeted, this will be greatly offset by higher loan recoveries. In consequence, the financing gap is likely to be smaller than budgeted and may fully neutralise the shortfall due to lower disinvestment proceeds, permitting the fiscal deficit to be bang on target although the primary deficit will be quite a bit off-course.

What are the implications for budget making for 2003-04? Despite 20 per cent growth in taxes, the deficit would have been basically kept in line by lower interest rates and capital cuts. The experience of recent years is that healthy tax growth is not attendant on successive years. Over the past eight years, annual tax growth has averaged just shy of 13 per cent. With lower inflation, growth in nominal incomes has declined to 9 per cent. Realistic assessments of tax growth are broadly defined by these limits. The odds are thus on lower growth in tax revenues in 2003-04.

Slashing capital items is the soft option in fiscal re-balancing, but there are obvious limitations. First, capex is more likely to be growth inducing, especially true for a country as deficit in physical infrastructure as India is. Second, with capex and net lending at 13 per cent of total expenditure (down from over 20 per cent in the 1980s), there is increasingly less to cut to compensate for shortcomings elsewhere in the Budget. Interest rates by any reckoning have bottomed and further saving on that account is unlikely to be available.

Which leaves hard options, if deficits are to be contained: Either raise effective tax rates by reducing tax exemptions to corporate and individuals and curtail non-interest revex items, primarily subsidies. The extent to which selective rates can be cut is severely constrained by the net revenue gain desired. Given the need to pare subsidies, the political economy of the Budget needs to be in balance. Of course, there is always the primrose path: The virtue of growth can be used to argue for larger capital outlays, sanctifying by association a larger deficit. A direction that, one hopes, will not transpire.

The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)