Explained: Fiscal Deficit threshold rises to 3.3% of GDP for 2018-19

By Priyanka Venkat 

The country awaited the budget for FY 2018-19 with high expectations. One important question on everyone’s mind though was, whether the balance between the need to appease the populace and fiscal prudence would be maintained. While the answer to this question will be better known at the end of next fiscal year, a look at the budget for 2018-19 could give us some insight.

Finance Minister, Arun Jaitley, fixed the fiscal deficit target for 2018-19 at 3.3% of Gross Domestic Product (GDP). This is higher than the 3.2% target that was set for 2017-18.  He also revised the fiscal deficit for 2017-18 ending in March at 3.5%, greater than the 3.2% target.

Fiscal deficit crossed threshold in April-November 2017

A fiscal deficit occurs when the government’s total expenditure is greater than its total revenue. As per government data, within the period of April-November 2017 itself, the fiscal deficit reached Rs. 6.12 lakh crore. This was greater than the total target of Rs. 5.47 lakh crore for 2017-18. This was largely due to a disparity in the growth of revenue expenditure vis-à-vis revenue receipts.

Revenue expenditure in this period grew to 13%, while revenue receipts grew by only 2%. Dismal collections under GST were seen, as a result of infrastructural issues that led to a delay in filing of returns, as well as cuts in tax rates for many items. The fall in revenue receipts is also largely attributable to the fall in non-tax revenue. Non-tax revenue includes transfers of surplus income by the RBI to the government and spectrum fees. Diminished receipts make it harder to spend on sectors that need the funds such as infrastructure. A high fiscal deficit, therefore, impedes a country’s ability to grow and could lead to a downgrade in India’s sovereign rating. Thomas Rookmaaker, Fitch Ratings Director and Primary Sovereign Analyst for India, highlighted the impact of feeble public finances on the country’s sovereign rating.

He said, “Weak public finances constrain India’s sovereign ratings, given a high general government debt burden of around 68 percent of GDP and a wide fiscal balance of 6.5 percent of GDP if states are included

Will the fiscal deficit be contained in 2018-19?

The budget for 2018-19 as expected focused heavily on building the capacity of the social and rural sector by increasing agricultural income through hiking of the minimum support price and building a more robust health and rural infrastructure.

Meeting the fiscal deficit is highly premised on whether the government is able to contain such expenditure within the budgeted limits, and also on whether revenue receipt projections actually come through. Revenue projections include a nominal GDP growth of 11.5% and a growth in gross tax revenue by 16.7%. Nominal GDP is a measure of economic output, without accounting for inflation. Nominal GDP could cross this figure if inflation increases in FY 19. The achieving of estimated tax projections depends on how further implementation of GST proceeds, and on whether firms who earlier evaded tax are brought under the tax net.

Where expenditure is concerned, the budget shows a certain level of pruning. The expenditure on the Department of Rural Development is set to increase by only 3.1% in 2018-19, compared to a 14.7% increase seen in 2017-18. Similarly, the budgetary allocation to the Department of Food and Public Distribution has increased by 19.4%, comparable to the current year’s increase of 26.7%. This department is responsible for funding the hike in the Minimum Support Price (MSP) in 2018-19. Even where health is concerned, allocation to the Department of Health and Family welfare will increase by only 2.4%, a lot lesser than the increase of 36.8% seen in the current year.

Pessimistic reactions

While budgeted expenditure has been reduced, it is possible that election pressures could lead to an increase in spending later in the year. Everyone isn’t too convinced with the government’s ability to meet the fiscal deficit target. On Thursday, after the finance minister finished his speech, 10-year bond yields hit a 22-month high and closed at 7.60%, higher than the earlier low of 7.37%. Yields rise when bond prices fall. The price of the bond fell because the demand for such bonds decreased due to low confidence in the government’s ability to repay its borrowings. Higher yields now mean that government will have to pay higher interest costs, which could reduce earnings and hinder future expansion. Reduced GST collections, the government’s plan to recapitalize PSUs and rising oil prices are only some of the factors that have affected the bond markets.

A spike in food price inflation is also possible, as the increase in MSP by 1.5 times of production cost would increase input costs, ultimately increasing the final price. The budget, therefore, indicates a possibility of a fiscal slippage as well as an upward movement in inflation, which could have a bearing on the country’s monetary policy. The year 2018-19 is likely to be a tumultuous but interesting one, and we can only hope that the government will finally exercise fiscal prudence and get the country back on track.


Featured Image Source: Pixabay