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High fiscal deficit threatens India's rating
Fri, 20 Jun Pre-Open

India's Union Budget is the next eagerly awaited event in the country. It holds a lot of importance as it would provide a glimpse of the roadmap that the new government plans to take to put the economy back on track. Moreover, in the budget, the government's approach towards fiscal consolidation may help in deciding India's sovereign rating. As per a feature in the Business Line, the coveted rating agency Moody's has expressed concern over the country's fiscal deficit situation. If India is not able to bring down the fiscal deficit, it may lead to a rating downgrade for the nation. In other words, the measures to increase government revenues - from its low base - and tame high current expenditures in the budget will have a big influence on the sovereign credit outlook for India.

India has been struggling with burgeoning fiscal deficit since credit crisis of 2008. The revised fiscal deficit in 2013-14 was 4.5 % of the GDP. The incongruity of low revenues and high expenses has widened the fiscal deficit over the years. India's large population and low per capita income levels are the key reasons for low income. Low income levels limit the government's tax revenue base. At the same time, low income puts pressure on the government to spend on subsidies as well as provide tax concessions which leads to a further increase in deficit. It is noteworthy that India's tax-to-GDP ratio has dropped to 10.2% as compared to a high of 12.5% in 2007-08. Also, non-tax revenues are quite low. Therefore, it is important that the government keeps its expenses under control. However, controlling expenses would mean curtailing of subsidies and curbing expenditure on various projects (power, infrastructure) which will again impact the policy reforms. Consequently, lower expenditure by the government will attract less investment which shall affect productivity and GDP growth. This will again initiate the vicious cycle of fiscal deficit, inflation and current deficit.

So how can fiscal deficit be curtailed? First and foremost the government needs to increase its revenue base and curtail unnecessary expenses. Divestment could be one of the ways. The money raised from stake sales in government owned or controlled entities will help keep the fiscal deficit under control. Another measure is to curtail subsidies particularly those related to diesel and oil. Deregulation of diesel prices as well as increase in natural gas prices will also aid in controlling deficit. Also, imposing a limit on the number of subsidized cooking-gas cylinders could help trim down the deficit. The implementation of economic reforms and increasing exports can help fast track the growth as well. This shall eventually lead to increase in revenues and can help the government in cutting down few non-essential subsidies.

Despite the impediments, the fiscal deficit target for 2016-17 is expected to be 3% of the GDP. We believe India needs to take crucial measures to narrow fiscal imbalances and work on structural reforms in order to realize this ambitious target. At the same time, the quality of consolidation is also of utmost important. This is because subsidies are an integral part of India's social and economic development. Therefore, if such benefits are to be taken away, they should be adequately compensated by other economic reforms that generate employment and lead to more revenues; thus eventually narrowing the fiscal deficit.

What impact will the new government have on the country's fiscal deficit? Share your views on the Equitymaster Club.

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