India’s Fiscal Situation (December, 2011)

India’s fiscal deficit crossed to US $45 million during the period April to December 2008, largely due to global financial turmoil.
In February 2009, the government had to revise upwards its fiscal deficit estimate for 31st March 2009 to Rs. 3.27 trillion which is
equivalent to the 6 per cent of the country’s GDP. The deficit has widened because of loan waiver, subsidies, pay-rise as per Sixth
Pay Commission, among other things, and is a cause of worry for both government and economists.

India started a fiscal consolidation programme in the 1990s putting restrictions on the new recruitment in public sector, and
strengthened it through the Fiscal Responsibility and Budget Management (FRBM). Under FRBM Act, the government set targets
for itself to reduce the fiscal and revenue deficits. This was the time when Indian economy entered its best period in terms of
economic growth. The GDP growth went into a higher trajectory of 7 to 9 per cent growth from the 4 to 5 per cent growth. During
2005-06, 2006-07 and 2007-08, India’s annual GDP growth was above 8 per cent before falling below 7 per cent in 2008-09
because of global meltdown. As a result, the revenues of the government jumped significantly.

This helped the government reduce its revenue as well as fiscal deficits year after year. The global crisis and slowdown in the
economy has forced the government to leave the path of fiscal discipline and spend extra to provide stimulus to the economy.

While the government was able to achieve the target of fiscal deficit of 3 per cent of GDP in 2007-08 them, a year ahead of the
target date, the target of zero revenue deficits could not be achieved. This happened because despite the lack of expenditure
reforms, the sharp rise in the revenue buoyancy aided by high growth, excellent corporate performance and tax reforms was good
enough to trigger a phase of steadily improving fiscal balances.

The dream run of improvement in the fiscal situation ended in 2008-09. The fiscal deficit of central government is expected to
touch 7.8 per cent of GDP as against the budget estimate of 2.5 per cent. This sharp rise in the deficit can be attributed to both
internal as well as external factors.

In 2008, the government implemented the recommendations of the Sixth Central Pay Commission which gave 5 million civil
servants a 21 per cent pay-rise. This put a burden of more than Rs. 12,500 crore on the state exchequer annually apart from a
onetime burden of Rs. 18,000 crore in 2008-09. So, the total burden for 2008-09 is Rs. 30,000 crore.

Following the decision of the central government, most of the state governments also had to give similar pay-rise to their
employees. The world’s biggest employment guarantee programme which is the flagship programme of the UPA government was
launched in 2006. This programme guarantees work of at least 100 days during the year to one of the family members who requires
job.

The scale of operation of National Rural Employment Guarantee Act (NREGA) has increased from coverage of 330 districts to all
604 districts of the country in 2008-09. NREGA is likely to provide employment to five crore households in 2009 with an
estimated expenditure of Rs. 30,000 crore.

The government announced farm loan waivers worth as much as Rs. 71,700 crore in 2008 to stop the farmer suicides due to heavy
debts. The government wrote off the debts provided by various banks and financial institutions to small and marginal farmers to
improve their financial position. But, this, in turn, has put tremendous pressure on the finances of the government.

The government also increased the minimum support price of the crops to support the farmers, and on the other, in order to
continue to provide the foodgrains at cheaper rates, the government provided significant subsidy in the Public Distribution System
(PDS) along with this, the prices of all types of chemicals went up sharply. As a result, the cost of producing fertilisers increased
significantly. But, the government decided not to pass on this burden on to the farmers and kept on providing high subsidies. Both
these subsidies have resulted in higher deficit. Some other reasons are briefly discussed below.

Rise in the Oil Prices: The crude oil prices have acted as the villain for the finances of the government. The prices for crude oil
went up from nearly $50 per barrel to a record high of $147 per barrel in July last year. Since India imports more than 70 per cent
of its crude oil requirements, the government had to provide bonds to the oil marketing companies to keep the retail prices of
petroleum products at lower levels.
Global Financial Crisis: As the global financial crisis deepened and started affecting the growth of Indian economy and availability
of credit, the GDP growth of the country came down from more than 9 per cent last year to less than 7 per cent for 2008-09. The
government is far from achieving its revenue targets due to fall in the tax revenues.

In order to revive the economy, the government announced three stimulus packages-two in 2008 and one in 2009. In the packages,
the government reduced various indirect taxes. The total revenue impact of these three packages is estimated to be more than Rs.
50,000 crore. In addition to this, there will be an additional spending of Rs. 20,000 crore in infrastructure sector.

Standard & Poor’s, one of the leading credit rating agencies which gives rating to the countries, recently lowered its outlook on
India’s debt rating to negative from stable, saying the country’s deteriorating fiscal position was unsustainable in the medium term.
In 2008, another international rating agency, Fitch Ratings, downgraded India’s local currency outlook from ‘stable’ to ‘negative’,
mainly on account of the deteriorating fiscal position of the union government.
Considering the worsening of the financial situation of the economy and downgrade of rating, many of the investors may begin to
move their investments out of India. If this lack of confidence spreads across investors, there can be significant outflow of capital.
This will lead to a sharp fall in the value of rupee which will further increase the debt of the country.

The fiscal situation will be the most important issue to be addressed by the new government. Since there will not be any significant
upward revisions in government revenues and the new government will require fulfilling some of its promises, it will keep pressure
on the deficits. Even in the interim budget for FY 2009-10, gross fiscal deficit is budgeted at Rs. 3,32,835 crore.

This is estimated at 5.5 per cent of the GDP. The 5.5 per cent of GDP ratio itself is very high and the actual deficit may turn out to
be higher. Therefore, the new government will have very little elbow room to expand the expenditure on social or infrastructure
sector. The Ministry of Finance has given clear signals of worsening situation by saying that the government will return to Fiscal
Responsibility and Budget Management (FRBM) targets once the economy is restored to its high growth path.

In fact, it is a difficult situation for the government. If the government does not pump in money and increase the fiscal deficit,
growth will suffer. And if it spends more, it will create significant liabilities for future which in turn will affect the rating. The best
alternative available to the government will be to return to the programme of disinvestment of Public Sector Undertakings (PSUs).
The government can divest 10 to 15 per cent from its about $100 billion ownership in state-run companies.

Another potential source of revenue for the government can be the much hyped 3G telecom spectrum. The issue has remained
clutched in the controversies between the GSM and CDMA technology operators leading to substantial delays. Moreover, the
tussle between the telecom and Ministry of Finance over the pricing of spectrum has added fuel to the fire. The Telecom

Ministry has set a target of 400 billion rupees from the now delayed 3G auction. But the Ministry of Finance has suggested a
doubling in the sale base price. According to the balance of payments (Bop) data released by the RBI, the capital account balance
saw a net outflow of $3.7 billion during the third quarter of the previous year. Capital account balance turned negative for the first
time since Q1 of 1998-99. There was net inflow of $31 billion during the corresponding quarter of previous year. The biggest hit in
the capital account came from portfolio outflows as FIIs pulled out $5.8 billion during the third quarter versus inflows of $8.9
billion.

The current account deficit widened to $14.64 billion in the October-December 2008 quarter from a revised $4.53 billion in 2007-
08. It was also much higher than the $12.83 billion deficit in the previous quarter. The overall Bop-the country’s external sector
balance sheet-witnessed a deficit of $17.8 billion compared to record surplus of $26.7 billion recorded in the corresponding period
a year ago. The main reason for this high trade deficit is sharp fall in the exports from the country. The exports are falling
continuously from October 2008 and in the month of March also, the figures are estimated to be worse. This negative growth is
expected to continue up till September 2009.
There is no doubt that India’s fiscal situation is in a bad shape.

The compulsions of injecting liquidity in the market because of the recession still remain. The new government has hinted at
bringing a new stimulus package to help the economy- which though good for many sectors-is not desirable on the fiscal front.
Prime Minister Manmohan Singh, in his second term, and the Finance Minister Prefab Mookerji have hinted at going for
disinvestment and privatisation, which seems the only way to improve finances apart from cutting down expenditure. Much will
depend on how the new government implements its plans.