The government?s pre-Budget move to reform India?s archaic and burdensome fertiliser subsidy regime is a timely acknowledgement of the need to rein in the fiscal deficit. India?s resilience through the global economic crisis can be explained by a number of factors, but what mattered when the financial crisis hit was the reasonably good state of the balance sheets of three critical components of any economy?households, corporates and the government.
Household and corporate balance sheets (including bans and financial institutions) were on the average sound?no overleverage, and in most cases limited exposure to overseas debt. The balance sheet of the government, on the other hand, was plagued by a fiscal deficit of around 6%. But by the standards of stimulus-prompted fiscal deficits (many in double-digits) in the West, India?s deficit looks reasonable. And the external debt component of the deficit is quite negligible.
Still, there are enough reasons now for the government to take the fiscal deficit seriously. For one, we have reached that point in the global economic cycle where all attention is focused on the state of government balance sheets. For the longest time, once the recovery began sometime in the middle of 2009, the commonly held view was that the big challenge for government policymakers would come from the side effects of very loose monetary policies. Most fears centered on asset-price bubbles and other inflationary pressures in both the West and in emerging economies. And then came the Dubai World default, the first sovereign debt default in the duration of this crisis?until then problems had been confined to household and corporate balance sheets, mostly in the West. It didn?t take long for markets to notice the massive government deficit-debt problems in certain European economies?the now infamous PIGS (Portugal, Ireland, Greece and Spain). The fear factor from Europe has been enough to deflate a number of potential bubbles, at least in stock markets. And nudge countries like India, which still need to attract investment from abroad to make a renewed effort to get the fisc back into shape.
But even if we chose to ignore the foreign dimension because of our limited dependence on foreign debt?a potentially expensive proposition, of course, if we want to attract investment?there are still reasons to be concerned about the fisc. Remember that unlike in Western economies, where fiscal pressures have built up largely due to stimulus efforts (including greater spending on unemployment benefits), India?s deficit has little to do with the post-crisis stimulus. Of course, some limited and specific tax concessions were made in the three stimulus packages of December 2008 and January 2009, but these were tiny compared to the unplanned stimulus that had happened in the run-up to the general election?the pay commission awards, the loan waiver and the continued extension of NREG. All of these, of course, played out as stimulus ex-post and stood the economy in good stead through the crisis, keeping consumption buoyant even as investment stuttered along. But unlike post-crisis stimulus, there is no question of a rollback in any of these.
The third reason to be concerned about the fiscal deficit is the toll that continued government borrowing is taking on the bond market. Bond yields are already under pressure because of inflation?government borrowing is additional stress. If borrowing isn?t reined in, there is a lurking danger of the government crowding out productive private sector investment. That is something we can ill-afford in our quest to achieve 9% growth in the near future.
So, what Budget watchers should wait for more anxiously than anything else this Friday are the government?s plans on fiscal consolidation. No one seriously expects the UPA government to slash public spending directed at social sectors. In fact, this will likely be scaled up. And there isn?t much room to increase taxes (other than the rollback in stimulus), though a firm announcement on the direct taxes code and GST may eventually help the government to mop up higher tax revenues while reducing the burden on individuals?essentially by broadening the base and bringing untaxed sectors into the tax net.
That leaves us with the subsidy bill and disinvestment. The promise to rationalise fertiliser subsidies was made in the last Budget?it took almost a year to materialise. But at least it happened. The finance minister could help the fisc this time by boldly announcing that he intends to accept the recommendations of the Kirit Parikh Committee report on deregulating oil prices, preferably immediately but at the least in this fiscal year. The government must, of course, lend more speed to disinvestment but there may be some caution on proceeding fast after the NTPC FPO fiasco. Getting SBI and LIC to mop up NTPC shares is hardly the optimal divestment strategy. Nor, as is now being discussed, is getting LIC and GIC to buy divested PSB bank shares at all satisfactory.
But most of all, the FM needs to restore credibility to the government?s balance sheet, a credibility that disappeared with the junking of FRBM-I. Might the yet unknown recommendations of the 13th Finance Commission on the fiscal deficit provide the anchor?
dhiraj.nayyar@expressindia.com