Hallelujah, the burdens of profligacy are reducing… - Views on News from Equitymaster

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  • Feb 15, 2007 - Hallelujah, the burdens of profligacy are reducing…

Hallelujah, the burdens of profligacy are reducing…

Feb 15, 2007

The Ministry of Finance is a happy and upbeat place to be in nowadays as the fiscal deficit – the excess of expenditure over income, what at personal levels will be a measure of living beyond one’s means -– is lower than that of last year’s. Expectations are that we will end this year with the Centre spending just 3.7% of GDP (sum total of all incomes of all Indian residents as well as Indian entities) over and above the income that it gets in the form of taxes and grants, compared to the excessively high fiscal deficit of 6.2% in FY02. The Fiscal Responsibility and Budget Management Act (FRBM) enjoins the Central government to bring its fiscal deficit down to less than 3% of GDP by FY09. There was a kind of desperation in the belt tightening as viewed along with the state government’s excess expenditures, we had almost 10% of our annual income being spent on keeping up with the government’s expenditure programmes.

A fast growing India, with incomes of people increasing as well as almost all businesses doing better along with a more tech-savvy Tax department, has seen a 34% YoY increase in total tax collections in the first seven months of FY07. This has helped cushion the 15% YoY increase in expenses between April and October 2007, as against the budgeted 11% for the entire year. That is to say, if God forbid there is a slight slowdown in the economy, the fiscal deficit targets will be very difficult to adhere to, if the government does not control the spending on itself.

What does the Big Brother spend on?
Most of this money was spent on running the ponderous government machinery --- between the Centre and the States, disbursement on building of new capital - basic infrastructure as well as social sector, was budgeted to be just 3% of GDP as compared to their total expenditure of 28% of GDP. Approximately 11.5% of GDP is to be spent on paying remuneration to people employed by the government in its social and economic forays like schools, hospitals, etc. Law, order, subsidies and expenses on collecting taxes get 7% of GDP. Interest payments on the government debt are a whopping 5.7% of GDP and the money borrowed seems to be mostly used to run the administration – in FY07, it was supposed to spend 12.6% of GDP on itself.

Heads of expenditure as % of GDP FY02 FY03 FY04 FY05 FY06 RE FY07 BE
Developmental capital 1.9 2.1 2.5 2.5 3.0 3.0
Developmental revenue 11.5 11.8 11.6 11.0 11.8 11.5
Interest payments 6.2 6.5 6.4 6.2 5.8 5.7
law, order, fiscal services, subsidies 7.3 7.4 7.0 7.2 7.0 6.9
Non developmental 13.5 13.9 13.5 13.4 12.8 12.6
(Centre and States combined; Source: RBI)

To reiterate, of the 17.4% of GDP that will be paid by us to the government as various taxes this year, only 3% of GDP will be spent on building better roads and schools for our children, on irrigation and power. Having said that there was fortunately an improvement – though small yet - in the growth in infrastructure spending in FY06 and is expected to continue in FY07. Also the delayed projects are being completed faster - the cost overrun of delayed projects has reduced in the last five years from 92% of the original cost to 36% by FY06.

Where does the money come from?
The government borrowed from the market, from small savings and provident funds and borrowed from abroad. When the markets had enough of government bonds, it just printed more money by borrowing from the Reserve Bank of India. Thankfully, the ministry has put a stop on this automatic monetisation of the deficit from FY97 as the government printed 0.8% of GDP in FY06. Monetisation helps if the money is spent on growing the physical assets in the economy. Otherwise, it leads to inflationary pressures building up. This is because the actual addition to the money supply is 5 times the monetisation, by the time the money gets recycled through the banking sector. Already the Consumer Price Index (CPI) - based inflation rate has doubled in the rural areas from an average of 3.3% YoY in the first nine months of FY06 to 8.9% in the same period of FY07 and urban areas have seen it grow from 4.1% to 6.8%.

The Reserve Bank of India by raising the CRR by 100 basis points since December 2006 has managed to absorb Rs 280 bn or 0.6% of GDP. Other than to ward off the evils of last year’s deficit financing, the RBI probably wanted to slow down the growth in credit to the ‘non-productive’ sectors of the economy. From the deployment of loans by banks as of June 2006, one can see an YoY increase in lending to retail by 47%, housing by 54% and commercial real estate by a dramatic 102% at the cost of reduced shares of the more ‘productive sectors’ like Agriculture - down from 14.1% to 13.4%, and Industry that reduced from 43.2% to 37.8%.

How will it affect growth?
All infrastructure industries except natural gas have bettered their targeted production for FY06 and continued the trend in the first nine months of FY07.

  Apr-Dec 2006 Apr-Dec 2005 FY06
Power generation* 7.6 4.9 5.1
Coal despatches 5.4 4.4 8.5
Cement production 10.3 9.8 11.2
Finished steel production# 8.7 10.6 6
Fertilisers 5.7 -2.5 1.1
Crude oil throughput 12.6 0.5 2.1
Cargo handled at ports 8.3 12.4 10.3
Railway freight traffic 9.7 9.7 10.7
Air passenger traffic # 33.1 19.3 23.7
Index of Industrial Production 10.7 8 8.2
* For the period April 2006 – January 2007
# for the period April to November 2006

The continued growth in the Index of Industrial Production (IIP) as seen in December 06 (11.1%) has renewed faith in the growth’s continuity ; a faith that was tested in October 2006 with the growth plummeting to 4.4% YoY. The base-effect was at play as the lower October figures can be attributed to loss of working days due to Diwali and other festivals which had been accounted for in November last year.

Most industries are working at 80% to 90% of their capacities. Investments have grown too; projects under implementation at Rs 9,887 bn are 14% higher than last year. This is over and above the Rs 2,736 bn that has flowed into the construction sector for 12 months ended October 2006. Together, they account for 32% of FY07 GDP. Increased capacities should fruition over the next 18 to 24 months. The current increase in interest rates can be absorbed by the potential expected growth. A slew of power and road projects that are on anvil will need huge investments at easy terms.

As excess demand gets satiated, most prices ought to stabilize by mid-CY07. Food prices should also taper off by then due to improved acreage under sowing in this rabi season. Having said that however, in order to smoothen the working of the real economy, the RBI will adjust liquidity positions to take care of the inflationary blip coming over the next six months till the enhanced capacities come on stream.

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