By Aurobindo Das & Nishant Kumar
Come Budget, and any talk about the fiscal deficit number tends to get touchy. So much so that you would almost begin to cringe over this obsession with one single number!
The catch is fiscal deficit and Budget are almost like two sides of the same coin. Over time, overseas investors and rating agencies have relied a lot on this number to judge the health of the Indian economy.
The government, too, has set itself a tough target with a roadmap to lower the fiscal deficit gradually in line with its Fiscal Responsibility and Budget Management (FRBM) target. The FRBM panel has recommended a fiscal deficit target of 2.5 per cent of the gross domestic product (GDP), revenue deficit of 0.8 per cent and a combined Centre-state debt ceiling of 60 per cent for fiscal year 2022-23, the end point of a six-year medium-term fiscal roadmap.
This forces the government to walk the proverbial tightrope every time the Budget comes, as it also has to attend to social sector needs and create enough stimulants for the growth engines of the economy to keep running.
Any slip on fiscal deficit discipline can also put the government at risk of inviting the wrath of the global rating agencies, whose outlook often determines the volume of investment flows into the domestic economy and markets.
In Budget parlance, fiscal deficit is the difference between total expenditure and total revenue of the government, except borrowings. It mainly stems from a deficit in revenue or hike in capital expenditure.
In other words, this is the total borrowing of the government to plug its budgetary gap. In recent times, there has been a lot of hue and cry about the possibility of a fiscal slippage by the Modi regime.
The government’s move to go for additional market borrowing only added fuel to the fire, as it is seen as a ‘negative’ that could take fiscal deficit to 3.5 per cent of gross domestic product (GDP), against Finance Minister Arun Jaitley’s goalpost of 3.2 per cent.
“India‘s fiscal deficit may widen to 3.5 per cent of gross domestic product in FY19 after breaching the target this year, since the government may go for fiscal easing and increase its spending in the run-up to the 2019 general election,” global brokerage Morgan Stanley said in a note.
Analysts have other reasons to worry, too.
A hardening inflationary environment is slowly rearing its head. Brent crude prices are back at the $70 a barrel level on the back of output cuts by Opec and non-Opec oil producers and robust demand from a global economy on the mend.
Surging oil prices mean a higher import bill for India, which will have to shell out more towards its oil bill. That, in a sense, will translate into higher expenditure.
The other worry line is faltering tax receipts, which are yet to shake off the twin impact of the goods and services tax (GST) and demonetisation.
Share sale in government entities picked up this financial year, but with the market outlook not that promising for the coming financial year, a question mark looms over the government’s ability to mop up too much revenue from that avenue. Of course, in recent times the government has been innovative in tapping that resource pool. But that’s a dormant resource till it is tapped.
So, the bottomline is that given the huge demand on it to meet social sector commitments and keep the public sector capex levels high, the government is staring at a huge gap between revenue receipts and expenditure going into the new financial year.
Market watchers say having a small fiscal deficit is not at all a bad idea. But there is a problem when the deficit swells and becomes untenable.
Credit growth in the economy is still on the mend and burdened with huge NPA loads, banks remain extra cautious in extending credit to industry. In a high fiscal deficit environment, government borrowing can crowd out bank credit, thereby forestalling any chance of capex revival.
Yet, some economists and industry veterans say there is nothing so sanctimonious about this number and the government can always relax it some bit and work on it later on.
“At this juncture it would be perhaps quite unwise to cut back on government expenditure, only because you are looking at the fiscal deficit number as something that is cast in stone. As long as that extra expenditure the government undertakes is for investment and not for consumption, I do not think why we cannot look at a slight relaxation in the fiscal deficit target. The heavens won’t crash or fall on us,” Mythili Bhusnurmath, Consulting Editor, told ETNOW.
This is exactly where the Budget holds a lot of suspense for markets. The Finance Minister will surely make use of all tools at his disposal to keep a tight leash on it.
Since global rating agencies put a premium on a lower fiscal deficit number, a good show on this front is always desirable as it allows a country to mobilise more foreign capital – key to bankrolling infrastructure projects and driving the economy higher.
A high deficit reading, on the other hand, comes with its own set of baggage, which signals high debt level and puts a question mark on the capability of the country to finance such debt, in the process impacting credibility.
More crucially, a manageable fiscal deficit means the government has more to spend on more productive areas rather than just channel its resources for debt financing.
High inflationary pressure remains the biggest headwind in deficit dynamics. Retail inflation spiked to a 17-month high of 5.21 per cent in December, which was much above RBI’s comfort zone of 4 per cent.
“We expect inflation to inch above 6 per cent in Q1FY19 and peak at 7 per cent in June 2018 on account of an adverse base effect. However, a high base is likely to pull down CPI inflation to sub-4 per cent in H2FY19. Thus, we expect the RBI to look through such statistical effects and maintain status quo through 2018,” brokerage Motilal Oswal Securities said.
The bond market is pretty touchy about the deficit number. The uptick in the CPI inflation and continuing concerns related to the Government of India’s fiscal deficit targets for 2017-18 and 2018-19 are likely to keep bond yields elevated in the near term, said Aditi Nayar, Principal Economist, Icra.
With rising oil and commodity prices, a net importer like India has its task cut out: to keep the deficit number healthy. Can the FM pull off this arduous job of striking a balance between the imperatives of growth and fiscal prudence on February 1?
That’s a billion dollar question, and quite literally so.