Tackling fiscal slippage

The Centre’s fiscal deficit touching 45.6 per cent of the full-year target within two months of 2014-15 poses huge challenges for Finance Minister Arun Jaitley, ahead of this government’s first Budget next week. But it is not the deficit target slippage as much as the underlying source that is the real worry. The Centre’s net tax collections during April-May were up just 3.1 per cent over the first two months of 2013-14, as against the 20.9 per cent growth based on the Interim Budget presented in February. Collections from excise duties, customs and corporate tax have actually recorded negative growth, which only points to the intensity of the ongoing slowdown. The latter is also reflected in the 2.3 per cent growth posted by the official index for eight ‘core’ industries in May.

It is quite possible revenue collections may show some improvement as an economic recovery gets underway. But that, as of now, looks a relatively distant prospect. So should Jaitley forget about the 4.1-per-cent-of-GDP fiscal deficit target set in the Interim Budget and aim at something more aligned to current revenue realities — say, 4.5 per cent, as Columbia University professor Arvind Panagariya has suggested? Well, the simple answer is that a flexible deficit target is fine in today’s environment, so long as this is accompanied by the implementation of a credible medium-term fiscal consolidation strategy. There are two things that the coming Budget can do, which would more than offset any adverse market reaction to a higher deficit projection. The first is to go in for an aggressive disinvestment plan to mop up ₹100,000 crore or more, which the current market conditions definitely allow. This will partly make up for the shortfall in the Centre’s revenue collections and rein in its deficit to that extent. More importantly, if the proceeds from disinvestment are used to fund capital expenditures in shovel-ready rail, road and other infrastructure projects, it will help kick-start investment activity and growth. These will, in due course, translate into buoyant tax revenues and lower deficits, as had happened during the high growth period of the last decade.

The second thing the Budget should do is unveil a clear plan for rationalisation of Central subsidies, that amount to almost ₹300,000 crore annually. At least half of this constitutes non-merit subsidies on fuel and fertilisers, neither promoting efficient resource use nor having significant positive externalities. These need phasing-out over the next 4-5 years, alongside a shift to a regime of direct cash transfers targeting genuinely poor and vulnerable households. An aggressive disinvestment programme and meaningful steps towards subsidy rationalisation — besides clarity on issues such as Goods and Services Tax rollout and retrospective taxation — will send out positive signals on the new government’s reform intent. In the event, it will matter least whether the fiscal deficit is 4.1 or 4.5 per cent of GDP.

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