Public Finances: In disarray amid the crisis

A lot has been said about the crippling impact of the global financial crisis on both the developed and the developing nations including India. While India has been in a much better shape than its peers in the developed world who have sunk into a recession, the state of India's public finances has left a lot to be desired. The unprecedented rise in global commodity prices during the first half of the year and deepening global financial crisis in the second half weighed heavy on the country's fiscal deficit (as % of GDP) which doubled to 6.2% in FY09. Infact, these adverse developments also wrecked havoc on what the government had envisaged as the terminal year of the achievement of the targets of the FRBM Act namely the fiscal deficit to be contained at 2.5% of GDP. In order to arrest the slowdown in the Indian economy, the government had resorted to fiscal expansion in the form of various stimulus packages which also had an important bearing on the direction of the fiscal deficit. What's more, the farm loan waiver, implementation of the Sixth Pay Commission and the funding of various projects prioritized in the Eleventh Five Year Plan further exacerbated the deficit, which was a far cry from the reduction that was witnessed between FY02 and FY07. Further, for the fiscal 2008-09, the revenue deficit stood at 4.6% of the GDP.

Source: Indiabudget.nic.in

The impact of the global crisis can be gauged by the fact that the revenue receipts barely managed to grow by 1%. What's more, the non-debt capital receipts plunged by 85% YoY largely due to the significant fall in disinvestment proceeds. Gross tax revenues managed to grow by a mere 2% YoY and the gross-tax to GDP ratio fell from 12.6% in FY08 to 11.5% in FY09. This was in sharp contrast to the trend witnessed since FY04, when tax collections were considerably buoyant.

On the expenditure front, the non-plan revenue expenditure rose by 32% YoY, with subsidies acting as a major dampener. The non-plan capital expenditure fell by 43%, which was not a good sign. Also, if one were to consider the total revenue expenditure (both plan and non-plan), then the same grew by 33%. As against this, the total capital expenditure (actual investment in asset creation) declined by 24% YoY. In our view, capital expenditure has to be increased substantially in the long-term interest of the Indian economy. To summarise, the revenue deficit for FY09 stood at 74% of the fiscal deficit.

Outlook
As has been highlighted in the Economic Survey, the existence of revenue deficit indicates that a part of the borrowings by the Government is not being used for financing public investment. When the focus is only on reducing the fiscal deficit, the brunt of fiscal correction is often borne by the reduction in capital expenditure. Hence, the change in revenue deficit on the path of fiscal adjustment indicates the quality of fiscal correction, which is as important as the level of fiscal correction itself.

The process of realizing the full growth potential of the economy through appropriate fiscal adjustments is a long-term process. While the sheer scale of the financial crisis hit hard the government's objectives to reduce the deficit, it remains to be seen how it manages to pull itself out from this state of affairs. Eventually, what the government needs to focus on is the curtailment of expenditure (especially on the revenue front), a fact which has not been witnessed this fiscal and in the previous fiscals as well. Though there exists headroom for further increase in tax revenues by improving the tax administration and the tax to GDP ratio, the critical factor is to reduce the expenditure by improving productivity and efficiency. And the government needs to do this by reducing the cost that it incurs in running the government machinery. While the current crisis has compelled the government to take corrective measures at the cost of straining its fiscal position, post the crisis, its mettle will be severely tested when it comes to bringing this deficit considerably down.