February 21, 2020
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The Dark Side Of The Upturn

Yes, the economy is beginning to surge, but it's also time to keep the deficits from doing the same

The Dark Side Of The Upturn
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Another election, another frightening picture. Only this time, it comes from one of the architects of reforms, Manmohan Singh. In his campaigns all over Delhi, the former finance minister is painting the economy in deep red with very high inflation as well as fiscal deficit lurking in the wings. And of course, blaming the successive non-Congress governments since '96 for it. Is this just election spiel? Or should we believe  him? Especially at a time when every indicator— and every industry chamber— is signalling a real economic upturn?

Yes, the upturn has started, but if the next government decides to ride this euphoria rather than fix some serious holes, it could fizzle out pretty quickly. In its annual report, the more- independent- than- ever RBI has warned the central and state governments that the combined revenue deficit jumped 61 per cent in 1998- 99 to about 5 per cent of GDP . As a result, the combined gross fiscal deficit— the central deficit plus the state deficits— fell just short of 9 per cent, the highest in the decade. Mainly on account of higher pay commission outgo— a whopping 1 per cent of GDP —and political giveaways.

But that was last year. Why should that affect 1999- 2000? It would, as in the states, consumption trends are worsening. And at the Centre, corporate revenues are yet to pick up. On the basis of the states' actual fiscal deficit of 4.3 per cent in 1998- 99, the combined targeted fiscal deficit in March 2000 may just end up above the previous 9 per cent, while projections of central fiscal deficit for 1999- 2000 range from 6.5 to 7 per cent per cent. Says Kirit Parikh, director of the Mumbai- based Indira Gandhi Institute of  Development Research ( IGIDR ), “An improved growth prospect could bring it to the lower end.” That will put pressure on more borrowing, raise interest payments and crowd out private  investments, resulting in high inflation and stunted growth. And Singh's spectre will take a plausible shape. More important, to keep that spectre at bay, the new government may impose a Kargil tax.

Just why is fiscal deficit so important? So much so that it has entered the average educated person's vocabulary? It is important because in plain language, it shows how much the government is borrowing every year to manage the shortfall in its income. Just as you or I cannot indefinitely run our house on credit card purchases, because the interest charges keep building up, so can't the government.

Right now, government finances are unsustainable because every year, it pays interest charges which are 10 per cent more than total new loans. For instance, the targeted fiscal deficit for this year is Rs 80,000 crore (excluding states' share of small savings), but interest  payments will be Rs 88,000 crore. Interest payments account for two- thirds of the Centre's  revenues.

The burden of debt has grown wildly in the '90s. Interest payments on public debt rose from 4.3 per cent of GDP in 1991- 92 to 4.7 per cent in 1997- 98. Says Parikh: “In '92, the government decided to borrow at market rates hoping this would make it more cautious with the cost of borrowing going up substantially. But this did not happen as politicians aren't bothered about costs.”

Politicians are also not bothered about government expenditure, the main cause of a ballooning fiscal deficit, the main components of which are: subsidies, losses on uneconomic government services and public sector units, and wages and salaries. While most experts feel there's very little scope for governments— central or state— to curtail expenditure in a big way in the prevailing political reality, not in the short run anyway, a recent study by IGIDR believes that non- plan expenditure can be brought down significantly provided the government targets subsidies.

For the Centre and the states, non-merit subsidies (economic services other than public goods like health and drinking water) net of surplus came to more than their combined fiscal deficits in 1994- 95, says a finance ministry study. Retargeting food subsidies may hike the total outgo but on all economic services front, there's a lot of money to be made. For instance, by levying user charges on all such services, this subsidy outgo can be halved from the unsustainable level of 11 per cent of GDP now, says IGIDR 's India Development Report 99- 2000.

Thanks to political pressures, expenditure overrun in 1998- 99 was Rs 14,000 crore. With such levels, our tax system simply can't catch up. At 17 per cent, our tax-GDP ratio is lower than the low developing country average and about half of the developed country average of 31 per cent. Indirect tax revenue has fallen over the '90s to around 15 per cent of GDP , though the share of direct taxes has  improved. With 60 per cent of the Indian economy in the unorganised sector and unreported, the ratio could be even smaller.

Instead of cutting subsidies, a virtually impossible task with coalitions, the government has actually thrown a lot of good money after bad PSU s this year. And post- polls, there will be about four months to achieve the disinvestment target of Rs 10,000 crore. Surely, a tall order. About borrowings, the less said the better. The RBI has completed 70 per cent of the target of Rs 79,995 crore in three months. The good side: rabi crop is buoyant, foreign direct investment is flowing in at double the last year's level, FII s are pumping money into a resurgent stockmarket.

SO, as Indian Statistical Institute professor Shubhashis Gangopadhyay says, “What's the special significance of the fiscal deficit this year? Haven't we lived with such figures for some time now?” The new thing this year, is— yes, you guessed it— the Kargil war. And, of course, a government that was reduced to a caretaker status soon after it presented its budget. Finance minister

Yashwant Sinha has estimated the Kargil outgo at around Rs 5,000 crore and hinted at a Kargil cess to recover the expenses. But the point to note here is that the ministry has yet to specify whether the expenses were out- of- budget or covered by it.

The cost of Kargil is around 11 per cent of the 1999- 2000 defence budget: Rs 45,694 crore. Most experts feel that India's defence budget, though considerably low at 2.5 per cent of GDP , is elastic enough to absorb the current costs. Further, says Bibek Debroy, director (research) at the Delhi- based Rajiv Gandhi Institute of Contemporary Studies: “The Kargil war doesn't merit a fresh tax. Our defence expenditure can do with some improvement of efficiency.”

But there's a big if. If the government decides in November to incur extra expenditure on defence, it will need to impose a cess. As a fiscallystrained developing economy, India can't afford the expense, but political pressures may be overwhelmingly for such a measure. A Kargil surcharge on all imports, or on corporates, may then be a reality. Says Parikh: “Kargil will increase defence expenditure because of the weaknesses it revealed. And a cess may be justified. There's every chance that the new government will do it.”

Sinha says that indirect tax inflow has  picked up, but not direct taxes. “The former implies a nascent recovery in purchases, while the latter shows that recovery has yet to impact corporates, the main contributors to direct taxes,” says Gangopadhyay. As a result, he adds, the recovery doesn't seem strong enough to warrant a scenario of high growth or high inflation. The RBI has projected a 6- 6.5 per cent real GDP growth for this fiscal, instead of the 7 per cent assumed by budget estimates. With inflation expected to average at 4 per cent for the year, the nominal expected GDP growth of 10 per cent, coupled with good news coming in from the farmers, could just be the safest bet for the government which will rule for the remaining five months of this dismal year. Perhaps Manmohan Singh doesn't really want to be in the finance minister's shoes at end October.

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