Let’s not be overawed : 5th October 2011 Financial Express

That the fiscal deficit was going to be exceeded was a foregone inevitability once the government reduced duties on oil products a few months ago, which would result in a fall of around R50,000 crore in tax revenue. The slowdown in growth in industry is indicative of excise collections getting under pressure while other collections like corporate tax and customs would be in the fuzzy zone for some time. The only way the situation could have been saved is by the denominator increasing to maintain the ratio at around 4.6% for the year. With the government/RBI now announcing a calendar for government borrowing of an additional R53,000 crore, the markets have been spooked. How serious is the issue?

The fiscal deficit ratio is the one which is under the control of the government to a large extent as it has the power to monitor the expenditure towards the end of the year, depending on how the revenue collections fare. Often in the past, project expenditure is scaled down to ensure that the ratio is maintained while the sluggish nature of approval of projects in the normal course adds to the comfort level. Admittedly, this will be a challenge, considering that some part of the NREGA allocation would have been spent by now. Therefore, there is a strong possibility of the budget still being manageable notwithstanding these slippages.

The fiscal deficit ratio of 4.6% was budgeted on the assumption that GDP at current market prices would grow by 14% in FY12. In real terms, GDP was projected to increase by 9%, consistent with 5% inflation. The way things have turned out, real GDP will grow by possibly 8% now, while inflation would average 9% for the year, thus bringing the nominal growth rate to 16%. The higher inflation rate will hence be quite fortuitous for the budget. This higher base will cushion the higher numerator, which will be higher by around R50,000 crore. The fiscal deficit ratio hence will be around 5% of GDP for the year under these conditions.

The only joker in the pack, so to say, would be the disinvestment programme, where the government started off with hopes of raising R40,000 crore and little progress has been made so far. While the market may not be exciting for raising money at this point of time when global markets are also gloomy, given the uncertain conditions in the euro area, any action of the government by itself can propel investors at a time when there is a drought in the market. But, certainly, this can upset calculations further, which could take the ratio to 5.5%, depending on the revenue shortfall on this score.

How about the money markets? Bond prices have been quick to respond, which is but natural, given that there will be an excess supply of paper, which, in turn, will depress bond prices and increase yields. But yields may not really soar to substantially higher levels if one looks at past trends. During June-August 2008, 10-year yields scaled the 9% mark and touched 9.32%, but this was not a year when borrowings were excessive. It was caused by tight monetary conditions, in terms of both liquidity and interest rates, at a time when there was a global financial crisis and RBI too had been aggressive in the market. Interest rates surely are high today given high inflation (which was subdued at that time). But liquidity is relatively easy, which is comforting in this situation. Also, traditionally, bond yields react more to liquidity conditions than the policy stance on interest rates.

RBI has already scaled down its projection for credit growth by 1 percentage point, which intuitively means that, on a base of R35 lakh crore as of March 2011, there would be a potential release of R35,000 crore for banks, assuming that deposits continue to grow smartly. In fact, the picture up to the first week of September shows that there is a large gap between incremental deposits and credit by around R1,30,000 crore, which is indicative of a twin phenomenon of growing deposits and subdued credit conditions. Therefore, liquidity should not really be an issue, though banks will not be too comfortable with declining bond prices as it would mean a hit on their mark-to-market valuation of their investment portfolio at the end of the year. Hence, their concern would be of a different kind, given that liquidity could be positive as long as growth in credit does not accelerate—which is anyway RBI’s goal, given its aggressive monetary policy stance.

All this means that while there will be a fiscal slippage, and our dream of moving towards the 3% fiscal deficit mark is still far away, conditions will not be too bad. Globally, too, deficits are high, with governments struggling to keep it under control. In fact, the new way of thinking everywhere is that higher deficits are useful to keep economies afloat. There is no reason why things should be different here in India.