As Finance Minister Pranab Mukherjee is all set to present his second full budget on February 26, there are some key concerns like rising fiscal deficit and withdrawal of stimulus measures, lingering in every investors mind. Here I have tried to analyse these concerns by looking at possible scenarios.
The stimulus packages have worked and as a result economy has again started registering positive growth. But the bad news is that, the government is under pressure to begin fiscal consolidation as India’s fiscal deficit has reached dangerous proportions on the back of the stimulus measures and due to rising government expenditure. The Prime Ministers Economic Advisory Council (PMEAC) has already warned the Govt that it can’t continue with unsustainable fiscal deficits recorded in the last two years and will have to start fiscal consolidation in the coming fiscal year (2010-11) to ensure fiscal sustainability, contain interest payments, to avoid upward pressure on interest rates and to curtail rising prices.
The current year’s estimated fiscal deficit is 6.8 % and is expected to be kept at 5.5% for FY2010-11 and 4% in FY2011-12. Though it is important to reduce the fiscal deficit, achieving this target by compressing capital expenditures drastically can be dangerous. According to Nobel Laureate Paul Krugman, “Any policy action to bring down deficit when the economy is still recovering from slowdown would be counter-productive.” Govt should not curtail capital spending significantly particularly in infrastructure as it is a critical growth driver for economy. Higher social sector and infrastructure spending will keep the consumption cycle in line with required economic growth rate.
As not much choice left on expenditure front, Govt will have to reduce fiscal deficit by focusing on revenue side. Implementation of Goods and Services Tax (GST) across the country and expansion of the service tax base in this fiscal will result in increase in revenue by about 0.5% of GDP. Also, disinvestment of PSUs and 3G spectrum auctions will generate additional revenue of more than Rs 70,000 cr. As Government is planning to remove unnecessary subsidies on petroleum products, this will also result in higher revenue. Higher corporate and income tax revenues are expected this fiscal as economic recovery is on right track. Also Govt is expected to increase the excise duty as step wise withdrawal of stimulus. Over all tax revenue is expected to go up by 15% in FY2010-11. Thus, by focusing on revenue side Govt can practically reduce fiscal deficit by 1.0 to 1.5% in FY 2010-11 without putting any pressure on economic growth. Higher revenue will also result in lower borrowing by Govt and thus lower crowding out of private investments.
Looking at overall scenario, I expect that the Govt will be able to bring down its fiscal deficit by 1.2-1.5% to 5.3-5.5% in this fiscal (FY2010-11) and that too without any adverse impact on economic growth. At the end, it is clear that Govt is going to tackle fiscal deficit by focusing on fiscal consolidation in coming budget. Rolling back the fiscal stimulus should also happen but in a calibrated fashion. With this it will be able to manage its long-term growth expectations with short term goal of economic recovery and lower inflation.
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