Improved public finances along with a buoyant economy have boosted the prospects of fiscal consolidation in the last few years. The consolidated (centre plus states) fiscal deficit declined to 6.2 per cent of GDP in 2006-07 from 9.9 per cent of GDP in 2001-02. The revenue deficit too has been trimmed from 7 per cent of GDP to 2 per cent in the same period. Fast growing tax revenues, which track the economy, widening of the tax net and the restructuring of the state finances due to the implementation of the Twelfth Finance Commission recommendations all contributed to the dramatic improvement. The broad indicators show that barring unforeseen circumstances we are broadly on track.
However, the numbers sometimes may not tell the complete story. Reducing the revenue or fiscal deficit is not enough as there are many off-budget items such as the oil bonds and the losses to state utilities. Together such items total up to around 1.5-2.0 per cent of the GDP. And as the central government gears up for an early election prior to the monsoons of 2008, there may be other populist pressures building up.
A recent note by JP Morgan points out to the adverse impact that the Sixth Pay Commission could have on the fiscal situation. The whopping Rs 53,000 crore pay-out in the mid-90s as part of the earlier Fifth Pay Commission implementation upset the fiscal situation for many years to come from which the economy has recovered only in recent years. This pay-out was to work in tandem with trimming the government workforce and other cuts in expenditure that were never implemented due to inadequate political will. That may well be the case this time around as well. Added to it is the mad rush for businesses to move into special economic zones. Though there has been no decisive number that has emerged for the likely revenue loss from these zones, it is clear that there will be some impact.
These factors may play out negatively if growth moderates to a less hectic pace. The Indian economy over the last two financial years has grown at close to a blistering 9 per cent. Any slowdown may well reduce the tax revenues as well, especially the corporate taxes. Add to this the inability of the government to reduce expenditure significantly and the prospect of slippage does not seem so unlikely. “Rigidity vis-à-vis interest payments, defense expenditure, and petroleum and fertiliser subsidies have rendered government spending highly inflexible,” observes JP Morgan’s economist Rajeev Malik.
So are we on track for a reduction of revenue deficit to zero and a trimming of fiscal deficit to 3 per cent of GDP by end of fiscal 2008-09? “We may achieve it or we may miss it by half a percentage point,” says Abheek Barua, chief economist with HDFC Bank. He adds, “as long as directionally we are correct, a minor slippage should not matter.” And nobody can doubt that we are headed in the right direction.
