Will The Modi Government Succeed In Balancing Its Books?

Shrinking Asia’s widest fiscal deficit is not proving to be an easy task.

The Indian government, which hopes to bring down its fiscal deficit to 3.5 percent this year, has a fine balancing act ahead of it if it hopes to meet the target. Government officials maintain that the goal will be met, but to do so expenditure will have to be watched and all sources of revenue will need to be tapped.

Between April and August, the government has already exhausted 76 percent of its budgeted fiscal deficit amount. This is the highest proportion of deficit exhausted in the first first five months over the last five years. In financial year 2015-16, 66.5 percent of the fiscal deficit amount was used up in this period.

This overshoot in spending raises two questions - Where has the money gone and will the government have to crimp spending in the second half to meet its fiscal goals ?

Where Was The Money Spent?

A number of ministries have spent more than half of their budgeted allocation, shows data available on the website of the Controller General of Accounts (CGA).

For instance, the Rural Development Ministry has spent nearly 67 percent of the budgeted allocation in April-August, mainly due to payments made under Mahatma Gandhi National Rural Employment Guarantee Scheme.

Other ministries like Civil Aviation and Consumer Affairs, Food and Public Distribution have exhausted over 51 percent of their budgeted allocation, data on CGA website show. The Ministry of Coal was allotted Rs 361 crore in this year’s budget, of which it has spent Rs 336 crore in April-August.

“…Early months of the fiscal were more devoted to spending on rural development, perhaps to alleviate rural distress. However, of late, spending on roads and railways has picked up considerably, said Kapil Gupta, research analyst with Edelweiss Securities.

The high deficit during these months is also the result of front loading of spending and a shortfall in non-tax revenues, said Gupta while adding that tax revenues has been strong so far.

Indirect tax collections jumped 26 percent in the April-September period while indirect tax collections increased 9 percent, shows data released by the government earlier this month. The government, however, has not garnered much through other sources such as disinvestment which has only yielded Rs 22,000 crore so far compared to the Rs 56,500 crore budgeted for. To be sure, the government’s coffers will also see inflows from the recently concluded spectrum auction and the Income Disclosure Scheme 2016.

Pronab Sen, former chairman of National Statistical Commission, explains that fiscal deficit figures in the first quarter of a financial year are also higher as excess tax paid in the previous year is refunded during that period.

Are The Government’s Finances Hurting Public Capex?

While economists are not unduly worried about the state of the government’s finances, some point out that public capex has been slow in the first half of the financial year.

In a report dated October 3, Pranjul Bhandari, chief India economist at HSBC pointed out that the growth rate of public capex spending has declined compared to last year.

Bhandari added that fiscal 2017 will not be a great year for investment demand as the government walks the fine line between macro stability (via meeting fiscal targets) and growth (via higher government capex).

While the Indian economy is expected to grow at 7.6 percent in fiscal 2017, much of the growth push is coming from consumption as private investment remains sluggish. Indian firms are reluctant to commit to fresh investments as capacity utilization remains low at close to 75 percent. As such, the burden of reviving investment demand in the economy falls on the government.

However, public capital expenditure from the government’s end has fallen as compared to the previous year, while revenue expenditure has witnessed a substantial rise due to outgo on account of salaries and pensions, said Jay Shankar, chief India economist and director of Religare Capital Markets. He added that pressure on government finances may increase as revenue expenditure rises due to higher salaries.

Pronab Sen, however, cautions against reading too much into the early fiscal deficit numbers. He cites the long monsoon as one reason that government infrastructure spending is yet to pick pace. Construction activity typically comes to a standstill during the monsoons.

Will The Government Meet Its Deficit Target?

Under the current fiscal consolidation roadmap, the government is committed to reducing its fiscal deficit to 3.5 percent of GDP from 3.9 percent last year.

Economists expect that this target will be met. The government garnered a lower-than-expected Rs 65,789 crore from spectrum auctions but finance ministry officials have said that this won’t impact the deficit target. In addition, the government has also received total disclosures of Rs. 65,250 crore under the Income Disclosure Scheme, 2016.

If the books still don’t balance out, the government may resort to a cut in public capex.

The report added that cutting public capex would further delay the recovery in the investment cycle. Investment as a percentage of GDP has slipped to 30.2 percent in the April-June quarter relative to 33.5 percent of GDP a year ago.

The government might also resort to some expenditure rationalization in the coming months, said Gupta of Edelweiss while adding that a slight slip on the fiscal deficit target will not be taken badly by the markets.

Over the medium term, the government may get some leeway in managing its finances once the committee set up to review the Fiscal Responsibility and Budget Management (FRBM) Act submits its report. The committee, which is expected to submit its recommendations this month, may recommend a fiscal deficit range rather than one specific target.

Having a fiscal-deficit range will be better as the 3 percent target set for the next year looks difficult to achieve, said Jay Shankar explaining that one-offs like the spectrum auction and the black money declaration scheme won’t help the government next year. The government will also have to shell out a significant amount as allowances of central government employees next year, he said.