India’s gross fiscal deficit for 2015-2016 could be 6.9 per cent of GDP, wider than the budget estimate of 6.3 per cent, according to an analysis. Although the Centre’s estimates show that it will succeed in keeping its fiscal deficit within the target of 3.9 per cent of GDP, a slippage is expected by the States as a whole. An analysis of the budget documents of States by HSBC Global Research estimates that the aggregate fiscal deficit for all States will be 2.7 per cent of GDP, wider than the official estimate of 2.3 per cent.
The study is based on the budget projections of 18 States, which make up just less than 80 per cent of India’s economy. These States released their budget projections for the upcoming fiscal year over the past month.
At 6-7 per cent of GDP, India’s General Government (Centre plus States) fiscal deficit is well above the norm for most emerging markets and in the worry zone, International Monetary Fund’s (IMF) Senior Resident Representative for India, Nepal and Bhutan, Thomas Richardson told The Hindu . “It must, in a gradual glide path, be brought down in line with other emerging market economies.”
The IMF estimates that the average fiscal deficit for the emerging market and middle-income economies was 1.1 per cent in 2015. For G20 emerging market economies it was 4 per cent. Its latest data shows that China’s general government deficit was 1.9 per cent of GDP in 2015 and is projected to rise to 2.3 per cent in 2016. The IMF calculates fiscal deficit differently than how it is done in India. It excludes disinvestment proceeds, which are essentially capital receipts, from the calculations for instance. Its estimate for India of 7.2 per cent for 2015 is, therefore, higher than the official estimates.
“We would like to see, over some horizon, the fiscal deficit reduced— by a widening of the tax base; Not by raising rates,” says Mr. Richardson.
Revenue collections Indeed, according to the HSBC study, the fiscal slippage in 2015 is because States’ revenue collections have disappointed. The revenue shortfalls can partly be attributed to the rapid fall in oil prices and the resultant disappointment in state governments’ value-added-tax collections. For some States, such as Rajasthan and Orissa, it also reflects lower-than-budgeted nominal GDP growth.
Though States cut expenditure to reduce the deficit, they by and large avoided touching capital spending, which saw only a minor decrease. Much of the hit was taken by current expenditure. This, the study concludes, is an important development as last year when the centre decided to give more untied funds to States following the 14th Finance Commission Award, the risk was that States would be reckless with spending. “It is heartening that India’s States, on aggregate, protected capital expenditure more than current spend,” it says.
The deficit widened despite the higher-than-expected funds transfers from the Centre on account of the implementation of the 14th Finance Commission award, according to the study, which projects further slippage this year: To 2.9 per cent, against the official estimate of 2.6 per cent. The spoilers this year are going to be the twin burdens of the wage hikes following the awards of the pay commissions of the States and the interest bill on UDAY (Ujwal DISCOM Assurance Yojana) bonds.
HSBC Global Research’s analysis of the budget documents also shows that for 2016-17 while States have made much more realistic revenue assumptions, they might have at the same time underestimated expenditure: “State Governments are grappling with two new spending pressures—the interest bill on UDAY bonds and pay commission wage hikes”.
According to latest available information, eight States will issue around Rs.1.8 lakh crore of UDAY bonds over 2016 and 2017. As per the norms, the State deficits will still have to finance the interest costs of these bonds.
The study estimates that it is likely to cost States 0.1 per cent of GDP in 2016-17 as interest pay-out.
Six of the 18 States studied, have made space for wage hikes in their fiscal accounts. These include Andhra Pradesh and Haryana.
Despite the fiscal slippage of the States, the study doesn’t see the aggregate government borrowings rising much this year. The higher borrowings of the States are projected to be offset by lower borrowings by the Centre, it says. In fact, one of the reasons why the Centre chose to retain the 3.5 per cent target, as per the Fiscal Responsibility and Budget Management (FRBM) roadmap in the Union Budget it presented last month, is that it wanted to make space for the expected increase this year in the States’ borrowing requirements.
According to RBI data, States borrowed a total of Rs.2.95 lakh crore last year, which is around half of the gross borrowings of the Centre, of Rs. Six lakh crore.
Higher borrowing Anticipating wider deficits and higher borrowing requirements this year, several States have already starting passing resolutions to borrow more, National Institute of Public Finance and Policy Professor N. R. Bhanumurthy told The Hindu .
“The importance of fiscal deficit is to know how much the government will have to borrow because that much pressure there will be on the liquidity available for the private sector’s needs,” Prof. Bhanumurthy says. It is for this reason the centre as well as the States’ deficits too should be factored in to macro-economic analysis, he recommends: “The FRBM framework, which the NDA Government is reviewing, should focus on the aggregate deficit for the country…I feel a certain uneasiness at the manner in which things are happening…In the absence of adequate understanding of the FRBM, we are saying it should be reviewed”. The 13th and the 14th Finance Commissions had based their recommendations on the FRBM analyses from Prof. Bhanumurthy, for which, he says, he had used the aggregate deficit.
Union Finance Minister Arun Jaitley has indicated that instead of fixed annual targets, the amended FRBM could specify a range for deficit to be contained within. However, the unpredictability even in a narrow range could trigger volatility in the markets.
The ability to pay up Over the medium term, Mr. Richardson says, fiscal deficits raise the issue of sustainability of public debt and the market perception of the sustainability. “You don’t want to be in a situation where the market and rating agencies worry whether you can remain solvent and can pay up.”
Lower levels of government borrowings can bring down borrowing costs for all borrowers – government and private--and thus restart the investments cycle and spur growth. “Fiscal deficit is tracked so closely because the money with which it has to be financed has to come from some place… The money used for funding it cannot be used for private investments. The pressure on availability can raise interest rates for private sector, making their growth more difficult,” says Mr. Richardson.
It has also been suggested by a number of public finance experts that in the revised FRBM framework, the Government must also commit to not borrow to finance consumption spending.
Over the long run, government borrowings to finance fiscal deficits raise inter-generational issues.
Mr. Richardson says: “If you borrow from the next generation it should be in better-return investments…private sector investments generate more growth than financing the fiscal deficit and you don't want to take from your children's pocket to finance current spending.”