by Rajesh Ramchandani
While presenting the first budget of the current government on August 1, 2014, the finance minister, Shri Arun Jaitley, stated that the fiscal deficit target of 4.1% of GDP for FY15, was a daunting task set by his predecessor. The task was certainly challenging even when compared with the preceding fiscal deficit levels of 6.46% in FY09 and 4.93% in FY12. With certain bold fiscal steps like linking petroleum products with market-linked price as well as restricting various subsidies, the government managed to limit fiscal deficit at the target level of 4.1% of the GDP for FY15.
Fiscal deficit target was then set at 3.9% of GDP for FY16, 3.5% for FY17, and then at 3% of GDP for FY18, as part of a fiscal prudence roadmap for the Indian economy. These revised fiscal deficit targets were achieved by government for the first two years. However, for the fiscal year ending 2018, the deficit slipped to 3.5%. For the following year, that is FY19, the fiscal deficit was set at 3.3% of GDP, which amounts to approximately ₹6.24 lakh crores.
Economic factors during current financial year
Crude Oil. Between the months of April and October 2018, the price of crude oil increased from USD63.41 to USD74.95, which is a spike of 18.2%. This rise is mainly attributed to the revocation of the Iranian nuclear deal by US and the imposition of economic sanctions. The event sent clear signals to the market about the shortage of supply in near future unless it is compensated by increased supply by other OPEC nations and the US.
Dollar price. Over the course of 2018, the rate of the US Dollar increased from ₹65.02 to ₹74.05. In other words, the domestic currency weakened by 13.88%, leaving a negative impact on the crude oil bill. Key reasons behind this are the trade war on China, Russia, and Turkey, in particular, whose currency, the Lira, depreciated by 40%, triggering depreciation of various other currencies across the world as well. The weak Indian rupee is also due to the rising interest rates in the US and a capital exodus by foreign institutions from the domestic economy.
Rising oil consumption. India’s consumption of crude oil and petroleum products increased by 5.29% from 194.6 million metric tones (MMT) in FY17 to 204.9 MMT in FY18, according to the data published by the Indian Ministry of Petroleum and Natural Gas. Similar growth rate can be expected in FY19. India’s dependency on import of crude oil and petroleum products is 83% of its annual consumption.
Oil price mathematics. Import bill is calculated thus: total import quantity times crude oil price times US Dollar rate. It can be observed that during the last financial year all three components have increased negatively impacting the oil bill.
|Example of price / consumption||Rise in current year||Current year values|
|a) Consumption (mmt)||100||5.29%||105.29|
|b) Crude Oil Price ($)||100||18.20%||118.20|
|c) Dollar rate (Rs.)||100||13.88%||113.88|
|Import bill (a times b times c)||10,00,000||14,17,268|
Net impact on import bill is seen to be increasing by massive 41.73%.
How does higher oil import bill impact the economy?
Current account deficit. In the year 2017-18, oil import bill was about 20% of total imports; the latter was at about USD459.7bn, which pegged the oil import bill at USD87.7bn. Oil price mathematics is going to increase this impact even further. The impact of a weak rupee on the non-oil import bill, which constitutes 80% of the import bill, is likely to worsen the situation further.
Higher oil price results in a circular cascade effect that weakens domestic currency as a result of the outflow of foreign reserves to foot the rising oil bill. Weak domestic currency will further raise oil bill in the next payment cycle, weakening it even further. This impact will continue till the time exports are not picking up meaningfully due to weak domestic currency. In the current financial year, current account deficit is likely to increase by another 1% of GDP over the previous year.
Revenue Receipts. Higher oil price has a domino effect by way of higher input cost and lower demand on the number of products. This leaves an impact on the bottom line of companies, thereby resulting in lower taxation, which leads to lower revenue receipts.
Revenue Expenditure. Higher oil price has a direct relation with inflation and, consequently, adds pressure on interest rates and bond yields. Government has already raised interest on small savings schemes. This will increase revenue expenditure and lead to higher revenue deficit.
Fiscal deficit. Higher revenue deficit will put pressure on fiscal deficit, as fiscal deficit is the difference between total expenditure minus revenue receipts.
Other factors like rise in minimum support price on agriculture produce will also leave their impact on fiscal deficit for the year. In the first five months of the ongoing financial year, fiscal deficit was already at ₹5.91 lakh crores, which covered 94.7% of government’s fiscal deficit target. This is a clear indicator that the fiscal deficit target of 3.3% of GDP will be compromised with a considerable margin in the current financial year.
The above slippage is mainly contributed to by external factors. However, with the government’s strong commitment to maintain fiscal prudence, we have reason to be optimistic for the Indian economy to come out of this temporary storm sooner than later.
Rajesh Ramchandani is a faculty of Finance at ITM-SIA Business School, Mumbai.
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