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India Economics
Asia Insight: It’s Time to Address the Fiscal Deficit Problem
Fiscal stimulus played a key role in the post crisis recovery, however, a persistent delay in reversing government spending and the resultant increase in inflation pressures is forcing the Central Bank to tighten monetary policy to control aggregate demand which is a sub optimal policy outcome. We believe fiscal consolidation will be necessary to returning to 8% plus growth path.
Key Debates
1)
High growth post crisis – was it the result of good policy mix?
2)
How does India compare with other EM’s in its fiscal consolidation process since the crisis?
3)
What is the medium-term solution to reduce the debt to GDP ratio?
4)
What if the government does not reduce the fiscal deficit substantially?
Fiscal stimulus played a key role in post credit crisis recovery: The government’s national fiscal deficit (central plus states combined) increased from 4.8% of GDP in F2008 to 10% in F2009. This expansionary fiscal policy has been a bigger growth driver than monetary easing over the past three years, in our view.
A large part of the increase since F2008 has been due to higher revenue expenditure: The government’s expenditure increase was largely centered around the revenue items wages, subsidies and national rural wage scheme. Even the capital expenditure taken up by the government tends to generate low efficiency capital asset.
Low productive nature of government spending brought inflation pressures: This boost to consumption via public spending helped to offset the shortfall in growth from the decline in private investment to GDP. In other words, less productive public spending substituted the decline in productive private investment. Although this approach was justified for a short period immediately post credit crisis, the government pursued this approach for too long, which meant persistent inflation pressures and higher current account deficit.
Maintaining high fiscal deficit and pursuing monetary tightening is a sub-optimal policy outcome: Ideally, the response from the policymakers should have been a quick reversal in less productive government spending, cut in fiscal deficit to boost overall savings and at the same time initiate policy measures to boost private investments. However, a persistent delay in reversing government spending and the resultant increase in inflation pressures is forcing the Central Bank to tighten monetary policy to control aggregate demand which is only adversely affecting the growth in private investment and taking non-accelerating inflationary growth potential lower.
F2012 Fiscal Deficit will likely be significantly higher than budgeted: We expect central government fiscal deficit to overshoot to about 6% of GDP in F2012 vs. budget estimate of 4.6% of GDP. We expect consolidated fiscal deficit (including states deficit) to be at 8.3% of GDP. Moreover, if we include off-budget expenditure, we estimate the national consolidated fiscal deficit will be 9.2% of GDP in F2012 (YE March 2012). Indeed, in 2011 we expect India to run the largest fiscal deficit among key emerging markets.
While many other AXJ countries resorted to fiscal stimulus post credit, India has reversed it the least: Overall fiscal deficit in India (including off-budget expenditure) increased from 4.8% of GDP in F2008 to 10% of GDP in F2009 and is expected to be at 9.2% of GDP in F2012 (YE March 2012). In AXJ ex India fiscal balance to GDP worsened from 0.8% of GDP in 2007 to -2.7% of GDP in 2009, however with the reversal in fiscal stimulus, fiscal balance to GDP is expected to improve to -1.9% in 2011.
What is the medium-term solution? To reduce the debt-to- GDP ratio, we believe that the government needs to address the primary deficit (consolidated), which stood at 4.5% of GDP in F2012, as per our estimates. The primary deficit is total receipts less non-interest expense or in other words the fiscal deficit less interest payments.
Fiscal consolidation is the key to returning to a higher growth path: Fiscal consolidation will be necessary for returning to 8% plus GDP growth. We believe that a heavy fiscal deficit burden is one of the major hurdles to the government achieving its GDP growth target of 8% plus on a sustainable basis. A sustainable reduction in the government’s deficit would likely have to entail difficult and sensitive measures, in our view.
What if the government does not reduce the fiscal deficit substantially? Clearly, an expansionary fiscal policy was supporting India's growth until recently – seemingly without any major concomitant costs. The costs of this policy will be evident in the form of higher real interest rates, lower resources for productive expenditure and slower growth, and these costs will be magnified if global capital inflows were to slow down, in our view.
Government is likely to miss the F2012 budget estimates for deficit by a big margin: Last year the government was able to reduce national (w/o off-budget items) and central fiscal deficit to 7.2% and 4.7% of GDP respectively, on account of the revenue from 3G license fees equivalent to 1.35% of GDP. However, this year the government is facing several receipt gaps. We expect central government fiscal deficit to overshoot to about 6% of GDP in F2012 vs. budget estimate of 4.6% of GDP. We expect consolidated fiscal deficit (including states deficit) to be at 8.3% of GDP. Moreover, if we include off-budget expenditure, national consolidated fiscal deficit would be 9.2% of GDP in F2012 (YE March 2012), on our estimates.
First, there is no one-off revenue from sources such as 3G license fees – Last fiscal, the government was able to consolidate fiscal deficit on account of the one-off revenue receipts from auction of 3G license which amounted to 1.35% of GDP.
Second, loss in revenue on account of cut in custom and excise duty on petroleum products – The government cut excise and custom duty on petroleum products in June this year, which will result in a loss of revenue of 0.5% of GDP.
Third, the ensuing growth slowdown is beginning to weigh on tax collections – Excise and customs duty growth has already slipped below budget estimates. Indeed for Sep-Oct average custom and excise duty growth was at 0.1% and -5%, respectively. Further corporate tax growth has also slowed to 7% in Sep-Oct vs. target growth of 20% for F2012.
Fourth, the government is finding it difficult to initiate the divestment program as planned in the budget -Given
the volatile capital market environment, divestment proceeds are only at INR 27.3bn currently vs. BE of INR 400bn.
How Has India Managed Relatively High Fiscal Deficit So Far?
Internal debt less external debt: First, and probably the most important factor that helps India manage this high level of public debt, is the fact that India’s deficit has been funded largely through domestic debt as opposed to external debt. In fact, the ratio of external public debt to India’s total public debt in the past 10 years has averaged at about 10.2% compared to 60% for all emerging markets.
Limited capital account convertibility: The Reserve Bank of India (RBI) has been careful in liberalizing the capital account for residents. Over the years, RBI has reduced the capital account restrictions for companies. However, there are still significant restrictions for individuals. Household savings remain captive for the government to fund its deficit.
Mandatory purchase of government debt by banks: Banks are required to invest 24% of their total net demand and time liabilities (NDTL) in government approved securities. This ensures a captive demand for government paper.
Capital inflows ensure the private sector does not suffer from crowding out: Typically, the cost of a high fiscal deficit would have been higher real interest rates. However, India has witnessed an unusually low real interest rate environment right at the time when its fiscal policy has been expansionary as reflected in rising public debt to GDP. The key to lower-than warranted real interest rates is the supply of global liquidity in the form of portfolio and debt inflows. About 74% of the total US$272 billion capital flows that India has received over the past five years have been in the form of non-FDI flows.
If global capital markets remain weak for longer, risk of crowding out will rise: We believe that if the ongoing deleveraging results in weaker global capital markets and therefore lower capital inflows into India, persistent high fiscal deficit will increase the real interest rates for the domestic private sector.
Fiscal Consolidation is the Key for Returning to a Higher Growth Path?
Fiscal consolidation will be necessary for returning to 8% plus GDP growth: We believe that a heavy fiscal deficit burden is one of the major hurdles to the government achieving its GDP growth target of 8% plus on a sustainable basis. A sustainable reduction in the government’s deficit would likely have to entail difficult and sensitive measures, in our view
First, the government needs to cut non-interest revenue expenditure. If we compare with other countries in the region, India’s tax to GDP ratio is one of the highest. The main reason for the high level of fiscal deficit appears to be higher expenditure. The government could initiate major expenditure reforms and move effectively to outcome-based expenditure management from the current outlay-based system to cut non-interest revenue expenditure. Over the past four years, there has been little control on non-development expenditure, which has been one of the key factors for the rise in total expenditure to 29.6% of GDP in F2011 from 27.1% of GDP in F2006. Indeed, including off-budget expenditure, total expenditure increased to 30.2% of GDP in F2010. In the same period, total receipts to GDP has increased by only 0.7% of GDP. Hence, we believe the key to better fiscal management will be to cut expenditure to GDP gradually over the next few years.
Second, interest costs currently form about one-fourth of total receipts and one-fifth of total expenditure. Indeed, interest costs have been consistently higher than capital expenditure since the mid-1990s. To control the interest cost component, India needs not only to stop accruing fresh debt for funding less efficient current consumption expenditure but also to reduce its stock of debt to GDP.
Third, accelerate privatization of public sector companies to reduce the debt burden ratio in a short period. Currently, the government is also suffering from a high debt service burden arising from past debt. While the public debt to GDP has been high, the good news is that the government’s assets have also increased significantly over the past few years. We estimate that the total value of listed government owned companies at about US$200 billion currently. This does not include value of unlisted government owned companies in about 238 companies, which could be significant as well.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Economics
Asia Insight: It’s Time to Address the Fiscal Deficit Problem
Fiscal stimulus played a key role in the post crisis recovery, however, a persistent delay in reversing government spending and the resultant increase in inflation pressures is forcing the Central Bank to tighten monetary policy to control aggregate demand which is a sub optimal policy outcome. We believe fiscal consolidation will be necessary to returning to 8% plus growth path.
Key Debates
1)
High growth post crisis – was it the result of good policy mix?
2)
How does India compare with other EM’s in its fiscal consolidation process since the crisis?
3)
What is the medium-term solution to reduce the debt to GDP ratio?
4)
What if the government does not reduce the fiscal deficit substantially?
Fiscal stimulus played a key role in post credit crisis recovery: The government’s national fiscal deficit (central plus states combined) increased from 4.8% of GDP in F2008 to 10% in F2009. This expansionary fiscal policy has been a bigger growth driver than monetary easing over the past three years, in our view.
A large part of the increase since F2008 has been due to higher revenue expenditure: The government’s expenditure increase was largely centered around the revenue items wages, subsidies and national rural wage scheme. Even the capital expenditure taken up by the government tends to generate low efficiency capital asset.
Low productive nature of government spending brought inflation pressures: This boost to consumption via public spending helped to offset the shortfall in growth from the decline in private investment to GDP. In other words, less productive public spending substituted the decline in productive private investment. Although this approach was justified for a short period immediately post credit crisis, the government pursued this approach for too long, which meant persistent inflation pressures and higher current account deficit.
Maintaining high fiscal deficit and pursuing monetary tightening is a sub-optimal policy outcome: Ideally, the response from the policymakers should have been a quick reversal in less productive government spending, cut in fiscal deficit to boost overall savings and at the same time initiate policy measures to boost private investments. However, a persistent delay in reversing government spending and the resultant increase in inflation pressures is forcing the Central Bank to tighten monetary policy to control aggregate demand which is only adversely affecting the growth in private investment and taking non-accelerating inflationary growth potential lower.
F2012 Fiscal Deficit will likely be significantly higher than budgeted: We expect central government fiscal deficit to overshoot to about 6% of GDP in F2012 vs. budget estimate of 4.6% of GDP. We expect consolidated fiscal deficit (including states deficit) to be at 8.3% of GDP. Moreover, if we include off-budget expenditure, we estimate the national consolidated fiscal deficit will be 9.2% of GDP in F2012 (YE March 2012). Indeed, in 2011 we expect India to run the largest fiscal deficit among key emerging markets.
While many other AXJ countries resorted to fiscal stimulus post credit, India has reversed it the least: Overall fiscal deficit in India (including off-budget expenditure) increased from 4.8% of GDP in F2008 to 10% of GDP in F2009 and is expected to be at 9.2% of GDP in F2012 (YE March 2012). In AXJ ex India fiscal balance to GDP worsened from 0.8% of GDP in 2007 to -2.7% of GDP in 2009, however with the reversal in fiscal stimulus, fiscal balance to GDP is expected to improve to -1.9% in 2011.
What is the medium-term solution? To reduce the debt-to- GDP ratio, we believe that the government needs to address the primary deficit (consolidated), which stood at 4.5% of GDP in F2012, as per our estimates. The primary deficit is total receipts less non-interest expense or in other words the fiscal deficit less interest payments.
Fiscal consolidation is the key to returning to a higher growth path: Fiscal consolidation will be necessary for returning to 8% plus GDP growth. We believe that a heavy fiscal deficit burden is one of the major hurdles to the government achieving its GDP growth target of 8% plus on a sustainable basis. A sustainable reduction in the government’s deficit would likely have to entail difficult and sensitive measures, in our view.
What if the government does not reduce the fiscal deficit substantially? Clearly, an expansionary fiscal policy was supporting India's growth until recently – seemingly without any major concomitant costs. The costs of this policy will be evident in the form of higher real interest rates, lower resources for productive expenditure and slower growth, and these costs will be magnified if global capital inflows were to slow down, in our view.
Government is likely to miss the F2012 budget estimates for deficit by a big margin: Last year the government was able to reduce national (w/o off-budget items) and central fiscal deficit to 7.2% and 4.7% of GDP respectively, on account of the revenue from 3G license fees equivalent to 1.35% of GDP. However, this year the government is facing several receipt gaps. We expect central government fiscal deficit to overshoot to about 6% of GDP in F2012 vs. budget estimate of 4.6% of GDP. We expect consolidated fiscal deficit (including states deficit) to be at 8.3% of GDP. Moreover, if we include off-budget expenditure, national consolidated fiscal deficit would be 9.2% of GDP in F2012 (YE March 2012), on our estimates.
First, there is no one-off revenue from sources such as 3G license fees – Last fiscal, the government was able to consolidate fiscal deficit on account of the one-off revenue receipts from auction of 3G license which amounted to 1.35% of GDP.
Second, loss in revenue on account of cut in custom and excise duty on petroleum products – The government cut excise and custom duty on petroleum products in June this year, which will result in a loss of revenue of 0.5% of GDP.
Third, the ensuing growth slowdown is beginning to weigh on tax collections – Excise and customs duty growth has already slipped below budget estimates. Indeed for Sep-Oct average custom and excise duty growth was at 0.1% and -5%, respectively. Further corporate tax growth has also slowed to 7% in Sep-Oct vs. target growth of 20% for F2012.
Fourth, the government is finding it difficult to initiate the divestment program as planned in the budget -Given
the volatile capital market environment, divestment proceeds are only at INR 27.3bn currently vs. BE of INR 400bn.
How Has India Managed Relatively High Fiscal Deficit So Far?
Internal debt less external debt: First, and probably the most important factor that helps India manage this high level of public debt, is the fact that India’s deficit has been funded largely through domestic debt as opposed to external debt. In fact, the ratio of external public debt to India’s total public debt in the past 10 years has averaged at about 10.2% compared to 60% for all emerging markets.
Limited capital account convertibility: The Reserve Bank of India (RBI) has been careful in liberalizing the capital account for residents. Over the years, RBI has reduced the capital account restrictions for companies. However, there are still significant restrictions for individuals. Household savings remain captive for the government to fund its deficit.
Mandatory purchase of government debt by banks: Banks are required to invest 24% of their total net demand and time liabilities (NDTL) in government approved securities. This ensures a captive demand for government paper.
Capital inflows ensure the private sector does not suffer from crowding out: Typically, the cost of a high fiscal deficit would have been higher real interest rates. However, India has witnessed an unusually low real interest rate environment right at the time when its fiscal policy has been expansionary as reflected in rising public debt to GDP. The key to lower-than warranted real interest rates is the supply of global liquidity in the form of portfolio and debt inflows. About 74% of the total US$272 billion capital flows that India has received over the past five years have been in the form of non-FDI flows.
If global capital markets remain weak for longer, risk of crowding out will rise: We believe that if the ongoing deleveraging results in weaker global capital markets and therefore lower capital inflows into India, persistent high fiscal deficit will increase the real interest rates for the domestic private sector.
Fiscal Consolidation is the Key for Returning to a Higher Growth Path?
Fiscal consolidation will be necessary for returning to 8% plus GDP growth: We believe that a heavy fiscal deficit burden is one of the major hurdles to the government achieving its GDP growth target of 8% plus on a sustainable basis. A sustainable reduction in the government’s deficit would likely have to entail difficult and sensitive measures, in our view
First, the government needs to cut non-interest revenue expenditure. If we compare with other countries in the region, India’s tax to GDP ratio is one of the highest. The main reason for the high level of fiscal deficit appears to be higher expenditure. The government could initiate major expenditure reforms and move effectively to outcome-based expenditure management from the current outlay-based system to cut non-interest revenue expenditure. Over the past four years, there has been little control on non-development expenditure, which has been one of the key factors for the rise in total expenditure to 29.6% of GDP in F2011 from 27.1% of GDP in F2006. Indeed, including off-budget expenditure, total expenditure increased to 30.2% of GDP in F2010. In the same period, total receipts to GDP has increased by only 0.7% of GDP. Hence, we believe the key to better fiscal management will be to cut expenditure to GDP gradually over the next few years.
Second, interest costs currently form about one-fourth of total receipts and one-fifth of total expenditure. Indeed, interest costs have been consistently higher than capital expenditure since the mid-1990s. To control the interest cost component, India needs not only to stop accruing fresh debt for funding less efficient current consumption expenditure but also to reduce its stock of debt to GDP.
Third, accelerate privatization of public sector companies to reduce the debt burden ratio in a short period. Currently, the government is also suffering from a high debt service burden arising from past debt. While the public debt to GDP has been high, the good news is that the government’s assets have also increased significantly over the past few years. We estimate that the total value of listed government owned companies at about US$200 billion currently. This does not include value of unlisted government owned companies in about 238 companies, which could be significant as well.
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