Walking the fiscal tightrope in India
Eighteen months into its term, the government in India remains committed to managing its fiscal deficit, and is on track to meet its fiscal targets for the year. However, the government continues to walk a tightrope to simultaneously manage the deficit while spurring economic growth – and will have to take stronger action next year to do this.
Efforts so far
Finance Minister Mr. Arun Jaitley said that the government will stick to its budgeted fiscal deficit target of 3.9 percent of gross domestic product (GDP) for fiscal year 2016 without cutting expenditure or deferring tax refunds, as past governments have been inclined to do. Fiscal consolidation continues to be a key pillar in the Modi government’s strategy for economic revival after inheriting a flagging economy and high fiscal deficit in May 2014. The government established the Expenditure Management Commission, which suggests significant reforms that will enable the government to reduce and manage its fiscal deficit at sustainable levels.
Increased tax collections have been the main driver of fiscal consolidation. Both direct and indirect tax collections registered a dramatic increase in the first half of FY 2016 compared to the average of the previous three years, a reflection of an improved tax administration and the first traces of revival in growth. In the last budget, the government announced additional revenue measures in the form of excise duty increases on diesel and petrol, while withdrawing exemptions from motor vehicles, capital goods, and consumer durables. The Clean India program, Swachh Bharat, will levy a 0.5% tax on all taxable services which increases the effective rate to 14.5%.
The government’s dilemma
While fiscal consolidation has so far been on track, the government could be pressured into raising its target of 3.5 percent for FY 2017. There is also a proposal to delay by one year the goal of a 3 percent fiscal deficit by FY 2018.
This pressure stems from the lower growth projections next year. Public spending has been the primary catalyst of growth in 2015; the government will be reluctant to reduce the capital expenditure needed to build infrastructure and boost economic growth, particularly since private investment has been weak. The government has also struggled to meet disinvestment targets by selling stakes in public sector undertakings, and the Finance Ministry is facing a shortfall of $7 billion.
A new outlook
Given that fueling growth next year will be difficult due to slow global growth, the government faces two options when balancing the fiscal scales – (1) revitalizing disinvestment and (2) reducing non-productive expenditure.
Since the first has not taken off the ground yet, the government is considering the second – reforming parts of its expenditure bill, despite these being politically inexpedient. The Secretary of the Department of Economic Affairs said that they are working on food and fertilizer subsidy reforms given the challenge of cutting capital spending. Food and fertilizer subsidies currently account for 80 percent of the total subsidy bill – a staggering $30 billion.
While the Expenditure Management Commission had been tasked as an independent body to reexamine subsidies and suggest reforms, a senior government official making this public commitment is significant, given that reducing the subsidy bill can be perceived as being “anti-poor” and “anti-farmer”. This is yet another indication of this government’s belief in an investment-led strategy to achieve growth objectives in the short term, and equity objectives in the long term.
How the government spurs growth while keeping its fiscal deficit under control remains to be seen – decisions on subsidies will be particularly interesting to wait for given their implications on the government’s investment plans.