India was one of the few countries that recovered within four quarters of the global financial crisis. The swift recovery, combined with large fiscal deficit and debt in the country, prompted the exit from the stimulus. Thus, the fiscal consolidation programme was re-initiated in conformity with the recommendations of the 13th Finance Commission. The consolidated fiscal deficit (including off-budget liabilities) relative to GDP was brought down from 10.6% to 9.4% in 2009-10 and further to 7.6% in 2010-11. The consolidated fiscal deficit for 2011-12 is budgeted at 6.7%, of which the Centre?s deficit is 4.6% and states? deficit is estimated at 2.1%. At the budgeted 2.2% of GDP for 2011-12, although the states? fiscal numbers look impressive, there is a hidden deficit of 1.5% of GDP on account of electric utilities.
The fiscal situation in the country surely is a cause for serious concern. It is doubtful whether the central government will be able to contain the fiscal deficit at the budgeted level of 4.6% of GDP. The doubts have arisen on account of sluggish growth of revenues and proliferation of subsidies on oil, fertilisers and foodgrains. Clearly, the budgeted increase of 18.5% over the revised estimate of 2010-11 would be difficult to realise due to the slowing down of the economy and sluggish direct tax collections. Given the state of the capital markets, it is also doubtful whether the government will be able to realise R40,000 crore of disinvestment proceeds.
On the expenditure side, many, including yours truly, had doubted the realism of the budget estimates when it was presented. The expenditures for the year were budgeted to increase at just about 3.5% over the revised estimates of 2010-11 and the increase in the non-interest expenditures was only about 1.4% over the previous year. The expenditure containment was to be achieved by mainly reducing subsidies by R20,583 crore (from R1,64,153 crore in 2010-11 to R1,43,570 crore in 2011-12). At a time when the average annual inflation rate is about 9% and in the absence of a political willingness to phase out subsidies, assuming that non-interest expenditure will increase by only 1.4% is clearly unrealistic. The unwillingness to decontrol the prices of petroleum products and increase the administered prices will only add to the fiscal deficit.
In the system of cash budgeting that is followed, it may be possible to carry forward a part of the deficit to the next year. Thus, even as the subsidy bill on oil, fertiliser or food front soars, only a part of the accrued subsidy may actually be disbursed and the remaining may be carried forward to the next year. This year, the oil subsidy is budgeted at R23,600 crore and the implicit assumption was that crude oil prices will remain at $90/barrel.
It appears there is already a carry-over of R20,000 crore to be paid to the oil companies from the last year and to this the budgeted amount this year has to be added. The expectation is that the government will disburse an additional R25,000-30,000 crore.
In addition, it may be necessary to pay substantially higher subsidies on fertilisers.
In the prevailing situation, as mentioned above, it will be extremely difficult to contain the Centre?s fiscal deficit at 4.6% of GDP. Although there may be some savings due to poor utilisation in some of the flagship programmes, the increases on account of additional dearness allowance payments and a higher subsidy bill on oil, fertiliser and food subsidies will be much larger. And even though the additional requirement on account of lower-than-budgeted revenues and expenditure increases will exceed the deficit over the budgeted by 1% of GDP in the revised estimates, that would provide alarming signals. The government may, therefore, exceed the deficit in the revised estimate by half a percentage point to 5% and push the remaining half a percentage to next year as unpaid subsidies and postponement of contractors? bills. This can be justified as the Finance Commission?s target for 2011-12 is 4.8% and another 0.2% can be justified in terms of the problems arising from the developments in the US and eurozone markets.
The problem of containing deficit is not just confined to the current year; it is even more formidable in the medium term when substantially higher allocation has to be made for education and health sectors as well as for food security. The Finance Commission has set the fiscal target of 3% of GDP for 2014-15 and that would require compressing the fiscal deficit by two percentage points over the next three years. In addition, there is a pressure to provide additional funding for health, education and food security, and the additional allocation for these sectors is estimated at about 3% on a conservative basis. In fact, the 12th Plan has to be formulated in this constrained fiscal environment and it poses serious difficulties in making adequate allocation to the much needed physical infrastructure.
Thus, in the medium term of the next three years, we need to make adjustment amounting to almost 6% of GDP by 2014-15. This has to come about either through increased tax collections or by phasing out unproductive expenditures. The gross tax revenue of the Centre, after reaching the peak of 12% of GDP in 2007-08, has shown a decline, and, in 2010-11, it is estimated at 10% of GDP. One possible measure at this juncture could be to change the personal income tax schedule to increase the marginal tax rate from 30% to 40%. An additional 10% for incomes above R25 lakh will be acceptable in the exceptional periods like this and the government can return to the more moderate tax regime in happier times. Another important measure the government should pursue with vigour is to reduce tax arrears. Tax arrears in India are estimated at more than R2,50,000 crore and a considerable proportion of this is stuck in litigations. It may be useful to evolve a strategy to negotiate and settle the cases out of court.
Difficult situations warrant drastic remedial measures. Hopefully, the government will evolve a workable strategy and muster sufficient political will to implement harsh measures well before the policy paralysis comes into play due to electoral reasons.
The author is director, NIPFP, and member, Economic Advisory Council to the Prime Minister. These are his personal views