Business Today

Why Deficit is not equal to Stimulus...

The UPA government blames the economic stimulus measures for a rising fiscal deficit. But this is not even half the truth.

Rishi Joshi and Puja Mehra         Print Edition: March 22, 2009

A fine line divides an excuse from an explanation. When it comes to the UPA government’s justification of the reasons for running up a massive fiscal deficit, this fine line is getting more blurred with each statement and action. The Finance Ministry and the Planning Commission almost sound offended if questioned on the fiscal slippage in 2008-09—the fiscal deficit having shot up to over 6 per cent of GDP, against the target of 2.5 per cent. After all, they argue, when the world is clamouring for supporting growth through massive public expenditure programmes, why be obsessed with the size of deficit?

Actually, the worry is not so much over the size, but the composition—and, therefore, purpose—of the deficit. Very few believe that the bulk of the deficit is because of the war chest that government has created to battle the fallout of the global economic meltdown. Says Sachchidanand Shukla, Economist with Enam: “The actual targeted stimulus is only about 2 per cent of the GDP, against the fiscal deficit of around 6 per cent of GDP.” What about the remaining twothirds of the deficit? That’s accounted for by the UPA’s largesselike Rs 65,300-crore farm waiver, the rural employment guarantee programme and the Sixth Pay Commission.

Added to that is overshooting of food and fertiliser subsidy targets—in part a fallout of global commodity inflation in the first half of this fiscal. “Persistence of populist measures like the farm loan waiver and the structural factors that accentuated the impact of cyclical factors (for example, fall in tax revenues) has made the fiscal situation vulnerable,” says D. K. Joshi, Principal Economist with Crisil.

Such criticism of the government also stems from the apparent attempts to hide the real deficit— and such attempts started much before the global economic crisis hit Indian shores in September 2008. While presenting the Budget of 2008-09 in February 2008, Finance Minister P. Chidambaram did not provide a single penny for the expenses to be incurred on the farm loan waiver and the Pay Commission implementation. Says Shukla: “The Finance Minister did some jugglery in the last year’s budget by not providing for the loan waiver and the Sixth Pay Commission.” The result: in October Chidambaram asked Parliament for Rs 1,05,630 crore as an additional grant to cover, among other things, the expenses that were announced in the Budget, but not provided for.

September and October were also the months when Chidambaram and the Prime Minister Manmohan Singh—and several other economic ministers—were claiming that the global crisis won’t impact India much. In reality though, October was the month when collections from tax revenues, something Chidambaram was betting heavily on, had begun to fall way below the previous year’s figures and well short of government’s target. In October 2008, tax revenues were 13 per cent less than the October 2007 collections. By December 2008, they were a good 25 per cent behind the previous year’s level.

While sources of revenues were shrinking because of the economic slowdown, the demand for pump priming the economy to prevent the slowdown was getting stronger. Having spent more than its due on populist schemes, the government had no choice but to shed all concern for the deficit and start spending like there was no tomorrow. It continues to do that even after presenting the Interim Budget—supposedly its last big economic policy statement. The measures like the 2 percentage point reduction in Service Tax and an additional instalment of Dearness Allowance to central government employees will stretch the government borrowing way beyond what was originally estimated.

A chunk of the record deficit (including the off-budget items like oil bonds, it will be around 8 per cent of GDP) that the UPA government will leave behind for the next government is a result of its mismanagement and miscalculations. For a government that presided over the era of fastest sustained economic growth, this is a most dubious legacy.

...And its consequences

The excessive borrowing to cover the deficit could squeeze private investment, denting the benefits of the government stimulus.
— Puja MehraRs 365 crore a day. That was the borrowing requirement of the Central government when the fiscal year 2008-09 started. If this seems huge, here’s what the requirement had gone up to by the time government presented the Interim Budget on February 16: Rs 838 crore a day. Or Rs 3,06,000 crore for the entire year. As it turns out, even this more than doubling of borrowing requirement isn’t going to be enough. Thanks to the stimulus announcements that kept trickling in after the Interim Budget, the final government borrowing figure for the year could well cross Rs 1,000 crore a day.

The problem, however, isn’t just the volume of borrowing. Even in the best of times, governments are the largest borrower in the market. What’s more worrisome is that the government is also the least risky—and therefore most preferred— borrower for banks. At a time when the downturn has tainted the creditworthiness of some of the best in India Inc., banks would naturally tend to prefer the biggest and the best customer—government. The rest of the economy could easily be starved of the funds. The government will, thus, “crowd out” other borrowers. Already, banks are holding about 26 per cent of their deposit money in government securities against the statutory requirement of 24 per cent.

Rajiv Kumar, Director & Chief Executive, Icrier
Rajiv Kumar
A fresh, huge supply of government debt in the market (Rs 34,000 crore of borrowing is still to be done for the current fiscal year) will also make reduction in interest rates less probable. On the Budget day itself, the 10-year yields shot up by 7 basis points to 6.36 per cent. Forcing RBI Governor D. Subbarao to signal base policy rate cuts the very next day. More than availability, it’s the cost of funds that producers and consumers are waiting to fall further. To make matters worse, S&P has lowered its long-term sovereign credit rating from Stable to Negative, which will raise the cost of foreign borrowing for several companies. The Indian private sector has $166 billion of foreign borrowing outstanding, and each 100 bps of higher cost of borrowing generates a direct hit of Rs 8,300 crore per year. A cold comfort is that the funds requirement of companies has gone down dramatically, reducing the demand pressure.

Funds raised during April-December 2008 have decelerated from both sources abroad (from Rs1,48,700 crore to Rs 98,100 crore) and domestic ones (from to Rs 1,25,900 crore to Rs 933 00 crore). On its part the RBI has tried to ensure adequate liquidity at a reasonable cost. Since September 2008, it has cumulatively cut the CRR by 4 percentage points (9 to 5 per cent), the repo rate by 3.5 percentage points (from 9 to 5.5 percent) and the reverse repo by 2 percentage points (from 6 to 4 percent). These steps released more than Rs 3,00,000 crore of liquidity into the domestic money markets.

Double Trouble
Government borrowings are hurting more due to the global credit squeeze.

Banks prefer risk-free investments. Non-food credit is up 19.4%, but banks’ exposure to government securities is up 22.6%

Reliance on banks is high as other taps are drying. Funds raised offshore fell to Rs 98,100 cr in April-December 2008 from Rs 1,48,700 cr in April-December 2007

ECB/FCCB are down from Rs 63,000 cr to Rs 27,600 cr

Funds raised from domestic sources are also down from Rs 1,25,900 cr to       Rs93,300 cr

Yet the easy liquidity isn’t resulting in lending on the ground. Barring a few state-owned banks, most have refused to take the cue from the RBI and are lending reluctantly— that too at rates higher than the RBI’s base rates. That’s because banks have become extremely risk-averse. They are turning away loan seekers from sectors carrying higher risk, such as real estate. After averaging at 25 per cent during April-December 2008, annual growth on bank loans has decelerated to 19 per cent in 2009. This is when, other than banks, most sources of funds have dried up substantially.

For another month or so the credit squeeze isn’t likely to get worse, as far as the availability is concerned. “Fears of crowding out private investment are exaggerated in the near term, as public spending is only substituting for slowing private investment,” says Rajiv Malik, Asean and India Economist with Macquarie Securities. Though true, this is neither healthy nor sustainable. Sooner rather than later, the right amount of credit at the right price will become absolutely critical to stem the downturn. RBI could consider structuring government borrowings better, especially the mix of the duration of the bonds by reducing the maturity period a bit.

Also on the RBI table is monetising about Rs 45,000 crore of the fiscal deficit by allowing the government to use the money it raised under the Market Stabilisation Scheme. Through this scheme the RBI neutralises the effect of its forex interventions on rupee liquidity produced by issuing government securities to the banking sector. The funds raised are not for government use. For the remaining amount, Government debt will be the safe, smart option for banks to park their deposits. Other borrowers be damned.


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