Economy: Fiscal Deficit: Vortex of Debt

The government's profligacy has caused the fiscal deficit to balloon. Unless some hard decision are taken, the crisis may deepen further.

"The state of India's public finances can verily be compared to that of a chain-smoking diabetic with a history of a few heart attacks. With such an addiction to "cigarettes" in the form of the penchant to dole out subsidies and otherwise plunder the state treasury at the drop of a hat, it is only a matter of time before crisis erupts."
-- The mid-year economic review for 1998-99, by the National Council of Applied Economic Research (NCAER).

Finance Minister Yashwant Sinha: caught in the deficit whirpool

The clock seems to be ticking at an uncomfortably fast pace. The monstrous fiscal deficit has been raising its head while the slowdown continues unabated. For the second year in a running it will probably be close to 6.1 per cent of the GDP -- double the level considered tolerable for developing countries. It will also be perhaps amongst the highest in the world. Had the Government not moved to take the short-cut route to disinvest, it may have touched 7 per cent. "The finance minister does not have too much space to do something about it while there are too many sacred cows in the budget that cannot be touched," says V.N. Pandit, professor at the Delhi School of Economics.

With no more soft options to control expenditure and half-baked efforts at mobilising higher revenue, there is a danger of the deficit climbing. The Government's profligacy is increasing the nation's indebtedness and constraining growth. While in absolute terms, the total debt has more than doubled from Rs 3,14,558 crore in 1990-91 to Rs 7,73,541 crore in 1997-98, the interest payments to service this debt are consuming larger chunks of the revenue inflows. In 1990-91, 40 per cent of the revenue went into interest payments. Now close to 48 per cent is required to service the debt.

In fact, with interest payments, defence spending needs and subsidies consuming as much as 78 per cent of the revenue, there is little left for productive investments. This forced Finance Minister Yashwant Sinha to curtail his plans to boost sectors such as infrastructure and housing by spending heavily. For the same reasons core industries such as cement and steel continue to face a sluggish demand. With the current levels of deficit, economists are getting anxious about the country's ability to handle sudden disturbances, both on the domestic and external fronts.

Tackle now, because...

Financing of the fiscal deficit works to constrain growth by pushing up inflation or interest rates.

High fiscal deficit reduces the Government's flexibility to handle shocks. Eleven consecutive good monsoons have increased the chances of a poor one this year.

On the external front, balance of payments could be under pressure with exports declining and foreign investors keeping away. New schemes to tap NRI savings will be expensive options.

More foreign exchange will be needed when international oil prices, currently at low levels, begin to rise as global economies pick up.

For instance, 11 consecutive good monsoons have increased the probability of a bad one this year. If that happens, it would retard agricultural growth. With industry already in a recessionary mode, this would adversely impact the economy.

The external environment too seems unsettling. Balance of payments could be under pressure with exports declining and foreign investments drying up. The Government managed to avert a foreign exchange crisis in 1998-99 by mopping up over $4 billion (Rs 16,800 crore) through the Resurgent India Bonds but repeating the exercise would be an expensive option.

It's been comfortable so far on the trade deficit front because international oil prices are at low levels. But as global economies pick up, oil prices will also rise. Says Pradeep Srivastava, professor at the Indian Council for Research on International Economic Relations and chief economist with the Delhi-based NCAER: "The situation is similar to that before the 1990-91 crisis. Even the Government realises that there is no escape now. The attempts that it has been making inspite of the political backlash indicates how grim the situation really is."

North Block has now decided to assert itself. It wants the fiscal deficit to incease by only 9 per cent this year against the average increase of 13.5 per cent in the 90s. To ensure that disinvestment receipts are on target, the Finance Ministry has worked out an innovative arrangement that allows select public sector undertakings to buy back their shares from the government or pick up stake in others. The Government expects to mop up more than Rs 7,000 crore this way. But experts feel this is merely an accounting exercise and not real privatisation. They point out that the buyback deals will constrain new investments by the PSUs.

Another gallant move was to reduce subsidies (see story) on rice, wheat, sugar, cooking gas and urea. This way the Government was expecting to save about Rs 450 crore on its total subsidy bill of Rs 19,883 crore in 1998-99. Maintains Manoj Panda, who teaches at the Mumbai-based Indira Gandhi Institute for Development Research: "The Government needs to take stronger measures like a large-scale disinvestment to reduce the public debt or a strategic change in its expenditure to send right signals to the economy."

That has been of little concern with successive governments. Public debt increased at a rapid pace through the '80s. As a proportion of the GDP, it shot up from 48.9 per cent in 1980-81 to as much as 67.4 per cent by the end of 1988-89. Most economists then took a view that growth in public debt would be desirable for a developing country like India.

But rising government expenditure and inadequate attention to mobilising inflows caused the fiscal deficit to spiral. From 3 per cent of the GDP in 1975-76 the fiscal deficit rose to 6 per cent in 1980-81 to 8 per cent in 1990-91.

The crisis of the '90s and the need to borrow from global banks forced the Government to be more circumspect. In its MOU to the IMF in 1991, the Finance Ministry said it would work to reduce the consolidated fiscal deficit from 12 per cent to 7 per cent by the mid-'90s. It also said it would reduce the Central Government's deficit from 8 per cent to about 5 per cent in 1992-93. But the progress has been abysmal. The consolidated fiscal deficit is still close to 9 per cent of the GDP while that for the Centre has been above 5.5 per cent for all but two years through the '90s.

On the revenue front, tax collections as a percentage of GDP have fallen though worldwide the experience is that they move upwards with reforms. "The Government took the politically acceptable decisions and ignored the politically difficult ones," says Indira Rajaraman, RBI chair professor at the National Institute of Public Finance and Policy. According to her, revenue reforms focused on bringing down tax rates at the upper end but efforts to widen the tax base have not received adequate attention. Similarly, the problem of tax evasion hasn't been given the attention it deserves.

The fiscal deficit may have been controlled in the 90s if the Government had focused on public sector reforms to earn higher revenues. But that did not happen. As a result, the nation continues to move from one crisis to another.