With the Mid-Year Economic Analysis painting a grim picture of the next financial year, officials in the North Block, which houses the finance ministry, are caught in a dilemma — how to stick to the path of fiscal consolidation while ensuring an uptick in the real economic activity in the next year’s Budget amid declining rural demand and low private investment.
According to the analysis tabled in Parliament last week, the slower-than-anticipated nominal gross domestic product (GDP) growth of 8.2 per cent against the budget estimate of 11.5 per cent in 2015-16 will raise the fiscal deficit target by 0.2 per cent of GDP. The government aims to achieve the fiscal deficit target of 3.9 per cent of GDP pegged for the current fiscal.
However, with the signs of revival in private investment not visible and an unlikely bounce in commodity prices, economists say that the nominal GDP is not likely to see significant improvement, thereby making it an uphill task for the government to balance its budgetary mathematics. As per the officials in the department, assuming 8.2 per cent nominal GDP growth and fiscal deficit at 3.9 per cent of the GDP, a 20 basis points increase in the fiscal deficit as a percentage of GDP translates into over Rs 20,000 crore in absolute terms.
While the Seventh Pay Commission is expected to add an additional 0.65 per cent of GDP to expenditure, one-rank one-pension obligations, the continuing weakness of private investment, stress on revenue collections and non-availability of gains from declining global oil prices, will further put pressure on the government finances. “It is in this context the government’s commitment to further fiscal consolidation of 0.4 per cent of GDP needs to be re-assessed,” the analysis has said. According to the fiscal consolidation roadmap, the government has pegged the fiscal deficit at 3.5 per cent of GDP and 3 per cent for 2017-18.
With the mid-year economic analysis ensuring a reality check, economists say that the government will have to look at ways to raise revenue, especially in the absence of non-tax windfalls like coal auction next fiscal. However, there is hope that the nominal GDP would fare somewhat better than the current fiscal.
“So far the decline in nominal GDP is external but indications are that rural demand is weakening, and private investment is not picking up. Due to base effect of commodity prices, the problem of declining wholesale price index will be sorted out. However under the constraints, the government will have to look at ways of raising taxes as there is going to be a sharp expansion of revenue expenditure on account of higher wages to staff. I see nominal GDP around 10 per cent,” Pronab Sen, chairman, National Statistical Commission, told The Indian Express.
Raising concern over declining nominal GDP, economists said that its decline will have impact on several indicators, including current account deficit, sales growth, growth in profit and tax collections.
A compression in nominal GDP has an impact on variables like sales growth, profit growth, revenue collections. In fact, credit growth is also far better explained by nominal GDP than real GDP. In that sense, it is a cause of concern. Then there is dilemma of pay commission. If the government treats it as demand support to economy, there is a fiscal cost to it. But I think despite that, a little deviation from the fiscal consolidation should not be much of a problem for the economy,” Abheek Barua, chief economist, HDFC Bank, said, explaining that there is a slowdown in both real and nominal GDP and the “fiscal policy should be sensitive to it”.
Despite the given slowdown, however, officials claim that the budgetary target of fiscal deficit will be met for the current financial year. As per government’s own admission, both the disinvestment and direct tax target will not be met. Further, it is unlikely that there will be any expenditure cut in the current fiscal.
However, though “the fiscal space might get constrained by around Rs 20,000 crore this year, it can be met through the additional revenue measures. Indirect tax collections are buoyant and will make up for the shortfall in direct taxes”.
In the Budget 2015-16, the government announced additional revenue measures in form of excise duty hikes on diesel and petrol, withdrawal of exemptions from motor vehicles, capital goods, and consumer durables, levy of 0.5 per cent Swachh Bharat Cess and and an increase in service tax rate to 14 per cent from 12.36 per cent. Disinvestment target of Rs 69,500 crore was set for the fiscal, including Rs 28,500 crore from strategic sale. However, the government has been able to raise an abysmal Rs 12,701 crore from sale of its shares in Rural Electrification Corporation, Power Finance Corporation, Dredging Corporation of India Ltd and Indian Oil Corporation. A shortfall of Rs 30,000-40,000 crore in the direct taxes has already been acknowledged by the revenue secretary Hasmukh Adhia.
Next financial year, according to chief economic advisor Arvind Subramanian, while the disinvestment targets are expected to be more “realistic”, the additional boost the economy received on account of declining oil prices — 1.5 percentage points — is likely to recede. Also, if the government sticks to fiscal consolidation, it would “further detract from demand” while with corporate balance sheets expected to recover slowly, private investment will not be significantly greater than in FY2016.
It is under these constraints that the finance ministry will have to prepare the Budget 2016-17. “It will be a difficult exercise because commodity prices are not expected to register any major bounce back while the advantage the government got in revenue collection this year due to falling global prices will also not be there. From policy perspective it will be a tough task to manage both external and fiscal account,” Madan Sabnavis, chief economist, Care ratings, said.
However he added that with subsidy bill being under control this year, it will provide some cushion to the government. Also, while the pay commission will increase the fiscal burden of the government, “a lot of it will come back to the government in form of taxes, so that should also bring some comfort,” he said adding that the real GDP will show some improvement in 2016-17.
On February 28, 2015, while presenting the Union Budget, finance minister Arun Jaitley had said he was presenting the “Budget in an economic environment which is far more positive than in the recent past.”
With around two months to go before he presents the Budget for FY17, it remains to be seen whether the same “positive” economic environment can be again invoked.