India’s success in trimming its fiscal deficit has surprised even itself but progress in the next two years will be harder as dizzying growth slows and pressure for populist spending rises before elections.
The not so good news in the deficit numbers is that the government relies on a higher tax collection rather than spending reforms to narrow the shortfall.
“So far it is higher revenues that have helped the government. They haven’t shown any effort to compress spending,” said A. Prasanna, an analyst with Mumbai-based ICICI Securities.
“Right now, you are at the peak of the cycle and when the measures taken by the central bank cool the economy, then there will be pressure on the deficit.”
Hitting a legislated federal deficit target of 3.0 percent and wiping out the revenue deficit by 2009 will depend how the government copes with higher interest rates and pressure to spend ahead of elections in two years.
Missing the target would raise the risk of higher bond supply and borrowing costs. And a government unable to straighten out its finances will spook investors whose expectations are already running high.
Hefty capital inflows have pushed the rupee to 9-year highs, making it Asia’s best performing currency this year. The booming stock market, which has hit successive all-time highs this month, is also vulnerable to a sell-off, analysts say.
A high fiscal and revenue deficit means government money can end up funding debt and non-productive spending rather than development, which will help keep the economic engines greased.