Fiscal deficit target: To relax or not to relax
Anand Adhikari January 27, 2017Will Finance Minister Arun Jaitley relax the fiscal deficit target of 3.0 per cent of GDP to provide room for more expenditure in 2017-18 or stick to his guns to follow the path of fiscal consolidation?
The debate or the speculations are once again raging in the market.
There was a similar debate in the last budget, but Jaitley refused to budge. While presenting the Budget 2015-16 , the finance minister underscored the government's commitment to achieve the medium term target of 3 per cent of GDP. Jaitley announced the targets for three years as 3.9 per cent for 2015-16, 3.5 per cent for 2016-17 and 3 per cent for 2017-18.
A year ago, the finance minister remarked that different schools of thought have argued either in favour of fiscal consolidation and stability or for a less aggressive consolidation and for boosting growth. "I have weighted the policy options and decided that prudence lies in adhering to the fiscal targets," Jaitley said in his budget speech.
If he deviates now , the finance minister has to give a strong justification for it. There are some who says he would be accommodating because of the likely adverse impact of demonetisation in the growth. The finance minister also shoulders a responsibility of preparing the groundwork for next general election in 2019? The assembly elections in close to half a dozen states including UP and Punjub are days after the budget presentation.
In a budget, the fiscal deficit is actually the excess of expenditure over government's earnings and the gap is filled by borrowings from the market especially banks and insurance companies. Globally, very few countries have budget surpluses. Developed countries like Germany and Switzerland are the fortunate few who are managing their house well.
Over the last one and a half decades, India has been making serious efforts to reduce its fiscal deficit level. The 14th Finance Commission had set a stiff fiscal deficit reduction to 3 per cent of GDP under the Fiscal Responsibility and Budget Management Act (FRBM) by 2016-17.
This target was extended by a year to 2017-18 by BJP led NDA government. In a way, the choices for Jaitley are limited but to adhere to 3 per cent commitment in Budget 2017-18. There are some who say Jaitley will take shelter in the recommendations of new FRBM panel, which has reportedly advised pressing the 'pause' button (on fiscal deficit target) to meet the infrastructure and other needs of the economy. Even some of the research houses have predicated a fiscal deficit target of 3.3 -3.5 per cent.
The message from the Reserve Bank of India (RBI) Governor Urjit Patel and the global rating agencies is very clear; follow the path of fiscal consolidation and push expenditure towards infrastructure and other productive purposes. A sustained and higher fiscal deficit is not good for the economy as it results in government's debt and also interest burden. Currently, 10 per cent of the budget expenditure is allocated for interest payments.
Currently, the general debt (which includes states also) is at a very high level of 66.7 per cent of GDP in 2015-16. This share was 80 per cent in early 2000 period. But there is no reason to cheer as the 66.7 per cent level is amongst the highest in the Group -20 countries. G-20 includes US , UK and BRIC countries. The size of the overall debt is Rs 83.69 lakh crore as against the budget size of around Rs 20 lakh crore.
While debt is not a taboo for a emerging economy like India, but there has to be a disciplined approach to achieve fiscal consolidation. Over the years, the sustained increase in GDP has helped taking care of the higher interest payments. With the clouds of uncertainty looming large as US, China still to recover from the economic shocks and domestic economy also witnessing some pressure, the higher interest burden would eat away resources meant for productive uses. Secondly, India has been financing its deficit through domestic borrowing ( over 95 per cent ), which leaves very little resources for the private sector.
This higher borrowing or the higher general debt to GDP is also one of the reasons for India's lower rating. Two months ago, the global rating agency, S&P, has ruled out a rating upgrade for India from 'BBB-' for the next two years. The agency, however, said a case for rating upgrade could be made if the overall debt to GDP falls below 60 per cent of GDP.
RBI Governor Patel also warned that borrowing even more and pre-empting resources from future generations by government cannot be a short cut to long lasting higher growth. "Instead , structural reforms and reorienting government expenditure towards public infrastructure are key for durable gains on the Indian growth front. Investment in public transport, specifically railways and Urban MRTS can lead to reduced costs and productivity gains as also help us to lower oil import bill, and, as collateral benefit, improve air quality in our cities," Patel advised.
It's no rocket science that benefits are much larger in following a fiscal consolidation path, but politics, too, plays its role in influencing a decision. Over to FM.