Economic Outlook for 2009/10 - Government finances - an overview – our outstanding liability is a horrendous 77% of the GDP
The Economic Advisory Council To The Prime Minister headed by Dr. C. Rangarajan has submitted its report on the Economic Outlook for 2009/10. This is what it says on Government Finances.
Government finances have come under severe strain since 2008-09, which is a matter of concern. After a steady improvement, particularly since legislating the Fiscal Responsibility and Budget Management Act ( FRBMA ) in 2003-04, the fiscal situation deteriorated sharply in 2008/09. The continued global recession and economic slowdown in the country called for a continuation of the expansionary fiscal policy stance in the current year. However, it is necessary to get back to the path of fiscal correction not only because of the problems associated with high levels of fiscal and revenue deficits, but also due to the role financing of deficits plays in calibrating monetary policy. Keeping a close watch on government finances is, therefore, important to ensure an appropriate balance between stimulating the economy to maintain a high growth rate while ensuring stability.
The government was successful in achieving substantial fiscal correction from 2003/04 to 2007/08. The consolidated fiscal deficit declined from 8.51 per cent in 2003/04 to 4.17 per cent in 2007/08 . Similarly, the consolidated revenue deficit relative to GDP was compressed from 5.79 per cent to 0.2 per cent during this period and the primary deficit moved into a surplus of 1.3 per cent of GDP in 2007/08 to provide a cushion in achieving debt sustainability. At the same time, it should be noted that fiscal correction was mainly on the strength of high growth of revenues from direct taxes and service taxes. A sharp increase in oil prices and the requirement to provide for civil services pay revision, loan waiver and expansion in the coverage of NREGA resulted in the revision of revenue and fiscal deficits to much higher levels. Thus, the revised estimate of expenditures for 2008/09 was higher than the budget estimate by 20 per cent, mainly due to 22 per cent higher revenue expenditures.
The fiscal deficit of the Centre as a ratio of GDP increased to 6 per cent as compared to the budget estimate of 2.5 per cent and the revenue deficit had to be revised to 4.4 per cent as against the budget estimate of one per cent. As the States were also allowed to have higher fiscal deficit amounting to half a per cent of GDP as a part of the fiscal stimulus package, the revised estimate of consolidated revenue deficit in 2008/09 as a ratio of GDP works out to 4.3 per cent and the corresponding fiscal deficit is estimated at 8.7 per cent. In addition, the Central government issued bonds for oil marketing companies and fertilizer companies amounting to 1.8 per cent of GDP. Thus, the total government liabilities for 2008/09 are estimated at 10.37 per cent of GDP
The above fiscal developments underscore four important points.
1. First, increase in deficits in the revised estimate over the budget estimate did not occur due to the stimulus package but on account of additional outlay on subsidies, pay revision, loan waiver, financing the increased coverage of the NREGA etc.
1. Second, the structural component of the deficit is substantial though a part of it is cyclical. The deficit on account of reduction in taxes on account of the economic slowdown as well as the tax cuts in excise and service taxes is estimated at about one per cent of GDP. The gross tax revenue of the Central government as a ratio of GDP declined from 12.5 per cent in 2007/08 to 11.5 per cent in 2008/09. This includes the impact of the economic slowdown as well as that of a six percentage point cut in excise and two percentage point cut in service tax rates. The remaining expansion is largely on account of an increase in expenditures on the items indicated above.
2. Third, the substantially higher revised expenditure over the budgeted expenditure, brings to the fore the poor expenditure management. While the fiscal deficit in 2008/09 was budgeted to conform to the FRBMA , approval for large amounts had to be secured through supplementary demands for grants. This adversely impacts expenditure management and allocative and technical efficiency in public spending.
3. Fourth, as the increase in expenditures was due to the reasons mentioned above, there was limited fiscal space for the stimulus package. In addition, the package could not be directed to the desired sectors. In particular, the stimulus package could have been used to augment expenditures on much needed infrastructure sectors, but large increases in current expenditures pre-empted this.
Considering the continued economic slowdown and global recessionary conditions, the Central government had to retain the expansionary fiscal stance during 2009/10 as well. The Union Budget for 2009/10 continues to maintain a high level of expenditure and has provided additional cuts in excise duties and services taxes besides increasing the borrowing room for the States to 4 per cent of GSDP or about 3.4 per cent of GDP. Thus, the fiscal deficit at the Central level as a ratio of GDP is estimated at 6.8 per cent and the consolidated deficit for the year is estimated at 10.1 per cent. As the government proposes to issue bonds to oil marketing companies amounting to Rs. 10306 crore or 0.2 per cent of GDP, the total increase in debt liabilities for the year works out to 10.3 per cent of GDP. Similarly, the revenue deficit of the Central government is budgeted at 4.8 per cent of GDP. As a number of States are expected to revise their civil service pay scales, after a brief period of generating a revenue surplus, these States are expected to incur a deficit of about 0.6 per cent of GDP. Thus, the consolidated revenue deficit is estimated at 5.4 per cent of GDP. The outstanding liabilities of the Centre and the States as a ratio of GDP (after a marginal decline to 74 per cent in 2008/09 from peak levels of 81 per cent in 2003/04 and 2004/05) are estimated to increase to over 77 per cent in 2009/10.
While the magnitude of the deficit is surely a matter of concern, it is important to note that the estimates for 2009/10 seem to be realistic as all expenditure commitments seem to have been budgeted and the revenue estimates do not seem to be overestimated. Although the drought situation in the country would require some additional expenditure both in terms of food subsidy and NREGA, it is not likely to alter the deficit estimates in any significant manner. Furthermore, moderate levels of prices of crude oil have obviated the need to have oil bonds and if the fertilizer subsidies are targeted as promised in the budget, the expenditure on this account can not only be contained at the budgeted level but the policy can be directed to improve efficiency in the use of fertilizers.
The large government deficits during the last two years were unavoidable; but it is not possible to sustain them in future. Given that the household sector's financial savings in 2008/09 was estimated at 10.9 per cent of GDP and is expected to be lower in 2009/10, continued borrowing of this magnitude is likely to put upward pressure on the interest rates and may financially crowd out private investment. Large fiscal deficits combined with large revenue deficits lead to using borrowed funds for current consumption and making transfer payments rather than creation of productive assets to generate externalities. Such large borrowings pre-empt a significant proportion of revenues for servicing the debt. In 2009/10, the spending on interest payment at 3.7 per cent of GDP is estimated at 36.6 per cent of the revenues accruing to the Centre and 19 per cent of Centre's expenditures. The build up of outstanding liabilities – estimated to be over 77 per cent of GDP in 2010 - also involves inter-generational equity as these have to be extinguished by raising taxes in future.
The macroeconomic environment depends not only on the volume of deficits but also the way they are financed. The annual monetary policy statement of the RBI estimates net market borrowings for the central and state governments for 2009/10 at Rs. 4,34,647 crore or about 7.2 per cent of GDP. Thus a significant proportion of the borrowing during the year is expected to be made by monetising the deficit. While a reasonably comfortable stock of food grains provides security against an increase in the prices of basic food items, in respect of some commodities such as pulses, sugar, edible oils, it may not be possible to augment supplies in the short run from domestic production and the government will have to maintain a close vigil on the price front.
The Next Budget: As the government starts preparations for the next budget, one important issue which needs to be addressed, is the appropriate “exit” strategy. It is important to return to fiscal consolidation and in determining this, both the timing and magnitude of adjustment in the coming years is extremely important. Indeed, given that the Centre would have paid out the salary arrears and the liabilities on account of loan waiver will be considerably lower, even if the expenditures on various schemes are kept constant in nominal terms, there could be a reduction in the deficit of 1.5 per cent of GDP next year. In any case, the government will have to wait for the recommendations of the 13th Finance Commission to determine the fiscal adjustment path. But it is important to return to the path of fiscal rectitude at the earliest.
Well, the situation is real bad and they are talking of the next budget, when we are dreaming of GST and they are talking of drought when two states were just washed away recently in floods. IT CAN HAPPEN ONLY IN INDIA.