The Hindu Business Line : Reining in the fiscal deficit

Can fiscal deficit be pegged at 2.5 per cent of GDP in 2008-09? With the likely slowdown in corporate and service tax collections and additional expense by way of the Sixth Pay Commission payment, it appears a challenging task.

Lokeshwarri S.K.

Fiscal deficit management has been a source of great satisfaction for the Finance Ministry. The country is on the way to reducing the fiscal deficit as a per cent of Gross Domestic Product (GDP) to below 3 per cent, much ahead of 2008-09, the target set under the Fiscal Responsibility and Budget Management (FRBM) Act.

The aiding factors

What were the prime factors that aided in controlling the fiscal deficit in 2007-08? Will the Government be able to control it at 2.5 per cent of GDP as promised in the Budget? The revised estimate for the fiscal deficit for 2007-08 is Rs 1,43,653 crore or 3.1 per cent of the GDP. The Budget estimate for the fiscal deficit for 2008-09 is Rs 1,33,287 crore; that would be 2.5 per cent of the budgeted GDP. This rapid reduction from the high of 6.2 per cent of GDP recorded in 2001-02 is laudable.

If we consider the factors that contributed towards controlling this mismatch in government finances, the primary reason is the strong growth in corporate profitability leading to higher direct tax collections. Corporate taxes that comprise about 32 per cent of the total tax collections surged by 39 per cent in the period between April 2007 and February 15, 2008.

The other driver for the growth in direct tax collections was the stock market boom. As turnover on the bourses made new records between August and December last year, the Securities Transaction Tax (STT) yielded Rs 7,878 crores (Rs 4,267 crores) to the exchequer.

Indirect tax collections, however, continued to be lag. Tax evasion could be the prime reason behind this slowdown. Customs duties were impacted by the strengthening rupee that resulted in lowering the cost of imports.

The Government has complemented the buoyancy in revenues by controlling expenses. The revised estimates for 2007-08 reveal that the total non-Plan expenditure rose by 23 per cent while the Plan expenditure increased 20 per cent over the revised estimates for 2006-07.

The moot question is whether the fiscal deficit can be controlled at 2.5 per cent of GDP as promised in Budget 2008. Post-budget clarifications issued by various Finance Ministry officials suggest that they are ready for at least a 50 basis points hike in the revised estimate for 2008-09.

The key factor that can affect this figure is the recommendation made by the Sixth Pay Commission. Since the report is due only on March 31, 2008, the provision for this increase has not been included in the Budget document.

Then there are the subsidies given to oil marketing companies, fertiliser companies and the Food Corporation of India in the form of bonds that have the potential to further inflate the fiscal deficit figure (if included in the Budget document as recommended by the Finance Minster in his Budget speech this year).

Questionable assumptions

Even if this unaccounted expenditure is ignored, certain assumptions made in budgeting for the revenue for 2008-09 are questionable. The receipts budget reveals that the estimate of the corporate tax receipts for 2008-09 is higher by 21 per cent. The other segment where higher revenues are provisioned is service tax, which is slated to increase to Rs 64,460 (Rs 50,603). In other words, the budget is assuming that the buoyancy in the corporate tax collections would continue in 2008-09 too. But it is widely known that there has been a slowdown in corporate profitability in the second and third quarters of 2007-08. If this prolongs, the corporate tax collections could slow down too.

The STT collections are also likely to decline in 2008-09. The previous fiscal witnessed an unprecedented rally in prices that sucked in a wide gamut of investors from all walks of the society. But the crash in January has resulted in many of these investors withdrawing from the market resulting in the turnover on the Bombay Stock Exchange and the National Stock Exchange plunging by more than 30 per cent.

The same argument holds true for the increase expected from short-term capital gains tax. With trading interest on the bourses at an ebb due to the lethargic movement of stock prices, short-term churn in portfolios is also likely to lessen.

New levies

However, new levies in the form of commodities transaction tax (CTT) and service tax on exchanges and clearing houses could enhance the revenue from this sector to some extent.

There is a segment of opinion leaders who decry this zeal to rein in the fiscal deficit, as it is resulting in the Government tightening the purse-strings where infrastructure-spend is concerned. These fears are justified since the Budget estimates for capital expenditure in 2008-09 is down to Rs 92,765 crore from Rs 1,20,787 crore in the revised estimate for 2007-08. The adherence to the FRBM targets is taking its toll on the outlay to the sectors, which are in urgent need for expansion.

It will be interesting to watch how the Finance Minister manages his finances next year given the likely slowdown in corporate and service tax collections and the additional expense in the form of the Sixth Pay Commission payment.