06-02-2005, 10:48 PM
<b>Commentary: India's fiscal advance, sadly, is an illusion</b> <!--QuoteBegin-->QUOTE<!--QuoteEBegin-->The proverbial light at the end of the tunnel for India's chronic budget deficits has turned out to be the headlight of an oncoming train. India's federal government announced this week that its most recent full-year deficit was 1.28 trillion rupees, or 4.1 percent of gross domestic product, the lowest since 1997.
Just three months ago, Finance Minister P. Chidambaram forecast the shortfall at 4.5 percent of GDP, unchanged from the previous fiscal year. He then said that deficit reduction, which is what investors and rating companies want the highly indebted Indian government to make its priority, was in a "pause" mode.
So what changed between Feb. 28, when the forecast was made, and March 31, when the fiscal year ended? While bond traders may be tempted to believe that Chidambaram has lifted his finger from the pause button and hit "fast forward," the reality is different.
<b>What's being paraded as a way out of the tunnel of fiscal imprudence is an illusion. One part of the drop in deficit is not sustainable; another part, if it is allowed to continue, may curb the economy's potential to expand. Lackluster growth is a recipe for a disastrous accident of the kind that in the past jolted similarly indebted nations - Argentina and Turkey.</b>
The government saved 52 billion rupees by cutting "plan expenditure," which is what creates new productive capacity and fuels economic growth. There was a gain of similar magnitude in the "nontax revenue," which includes the interest the government earns on loans to provincial authorities and the dividends and profits it gets from state-owned companies and the central bank.
It's a windfall. Only once in the previous six years did the government underestimate in February what it was going to earn as nontax revenue in the year up to March. That was in 2004. And at that time, the difference between what was predicted and realized was only 5.8 billion rupees. The gap is almost 10 times larger now, forcing one to question the validity of the forecast.
The two factors - the squeeze in plan expenditure and the jump in nontax revenue - together accounted for 93 percent of the net improvement in the budget deficit over the February forecast.
The reduction in India's headline budget deficit is taking place just the way economists say it shouldn't.
"In addition to deficit reduction per se it is the manner in which this is effected" that matters, Errol D'Souza, an economist at the Indian Institute of Management, Ahmedabad, wrote in the journal Economic and Political Weekly. "Reduced public investment and increased tax rates aren't as effective as cuts in current expenditures (including subsidies) and the public wage bill."
To be sure, Chidambaram isn't raising tax rates. He has just cut the corporate tax levy to 30 percent, from 35 percent.
That's the most he has been able to push. The government's Marxist backers who are opposing its plan to raise about half a billion dollars by selling a 10 percent stake in a state-run power-equipment maker are unlikely to allow a major cutback in subsidies.
As a result, the federal government wants to make new investments worth only 1.9 percent of GDP this year. That's the lowest in four years, and clearly inadequate to meet the needs of the second-fastest growing major economy after China.
One can argue that India's entrepreneurs should be the ones making investments, with overseas investors filling in wherever required; the government bureaucracy is inefficient, and should therefore have no role beyond regulation.
That argument would perhaps be true in another 20 years. The kind of investments India needs most urgently is in basic infrastructure where gestation periods are high and returns low.
<b>India will need $46.5 billion for improving urban transportation over the next two decades; it will require another $38 billion between now and 2021 for water and sanitation in urban areas.
The government must spend $40 billion over the next 10 years to widen highways, and invest $13 billion a year to meet the country's power needs, the International Monetary Fund estimates</b>.
All of this adds up to a lot of money, and the government won't find it in the local bond market. Unless real interest rates decline, the economy will have to become super-efficient, generating $1 of GDP for every $1 of investment, only to stabilize public debt at an already-high 81 percent of GDP, IMF researchers say.
Nothing about India's budgets is as it seems. This year's deficit target of 4.3 percent was set after removing from consideration 290 billion rupees of the federal government's expenditure: the money it lends to provinces for financing their economic plans.
It was an independent commission that ordained that provincial governments raise the money directly from the market. Even so, the expenditure remains intact on the consolidated accounts of the federal and the state governments. A combined deficit of about 9 percent of GDP is what spooks rating companies like S&P, which rates India's local-currency debt below investment grade.
Without this accounting change, the federal deficit would, instead of falling to 4.3 percent, rise to 5.1 percent, D'Souza, the economist, estimates. A one percentage point jump in the deficit from last year just when rising interest rates are likely to push up the government's debt-servicing costs would mean asking to be hit by that oncoming train.
When it comes to paring deficits, Chidambaram isn't in a pause mode. He is actually rewinding the tape - not because he wants to, but because the Marxists won't have it any other way.
The proverbial light at the end of the tunnel for India's chronic budget deficits has turned out to be the headlight of an oncoming train. India's federal government announced this week that its most recent full-year deficit was 1.28 trillion rupees, or 4.1 percent of gross domestic product, the lowest since 1997.
Just three months ago, Finance Minister P. Chidambaram forecast the shortfall at 4.5 percent of GDP, unchanged from the previous fiscal year. He then said that deficit reduction, which is what investors and rating companies want the highly indebted Indian government to make its priority, was in a "pause" mode<!--QuoteEnd--><!--QuoteEEnd-->
Just three months ago, Finance Minister P. Chidambaram forecast the shortfall at 4.5 percent of GDP, unchanged from the previous fiscal year. He then said that deficit reduction, which is what investors and rating companies want the highly indebted Indian government to make its priority, was in a "pause" mode.
So what changed between Feb. 28, when the forecast was made, and March 31, when the fiscal year ended? While bond traders may be tempted to believe that Chidambaram has lifted his finger from the pause button and hit "fast forward," the reality is different.
<b>What's being paraded as a way out of the tunnel of fiscal imprudence is an illusion. One part of the drop in deficit is not sustainable; another part, if it is allowed to continue, may curb the economy's potential to expand. Lackluster growth is a recipe for a disastrous accident of the kind that in the past jolted similarly indebted nations - Argentina and Turkey.</b>
The government saved 52 billion rupees by cutting "plan expenditure," which is what creates new productive capacity and fuels economic growth. There was a gain of similar magnitude in the "nontax revenue," which includes the interest the government earns on loans to provincial authorities and the dividends and profits it gets from state-owned companies and the central bank.
It's a windfall. Only once in the previous six years did the government underestimate in February what it was going to earn as nontax revenue in the year up to March. That was in 2004. And at that time, the difference between what was predicted and realized was only 5.8 billion rupees. The gap is almost 10 times larger now, forcing one to question the validity of the forecast.
The two factors - the squeeze in plan expenditure and the jump in nontax revenue - together accounted for 93 percent of the net improvement in the budget deficit over the February forecast.
The reduction in India's headline budget deficit is taking place just the way economists say it shouldn't.
"In addition to deficit reduction per se it is the manner in which this is effected" that matters, Errol D'Souza, an economist at the Indian Institute of Management, Ahmedabad, wrote in the journal Economic and Political Weekly. "Reduced public investment and increased tax rates aren't as effective as cuts in current expenditures (including subsidies) and the public wage bill."
To be sure, Chidambaram isn't raising tax rates. He has just cut the corporate tax levy to 30 percent, from 35 percent.
That's the most he has been able to push. The government's Marxist backers who are opposing its plan to raise about half a billion dollars by selling a 10 percent stake in a state-run power-equipment maker are unlikely to allow a major cutback in subsidies.
As a result, the federal government wants to make new investments worth only 1.9 percent of GDP this year. That's the lowest in four years, and clearly inadequate to meet the needs of the second-fastest growing major economy after China.
One can argue that India's entrepreneurs should be the ones making investments, with overseas investors filling in wherever required; the government bureaucracy is inefficient, and should therefore have no role beyond regulation.
That argument would perhaps be true in another 20 years. The kind of investments India needs most urgently is in basic infrastructure where gestation periods are high and returns low.
<b>India will need $46.5 billion for improving urban transportation over the next two decades; it will require another $38 billion between now and 2021 for water and sanitation in urban areas.
The government must spend $40 billion over the next 10 years to widen highways, and invest $13 billion a year to meet the country's power needs, the International Monetary Fund estimates</b>.
All of this adds up to a lot of money, and the government won't find it in the local bond market. Unless real interest rates decline, the economy will have to become super-efficient, generating $1 of GDP for every $1 of investment, only to stabilize public debt at an already-high 81 percent of GDP, IMF researchers say.
Nothing about India's budgets is as it seems. This year's deficit target of 4.3 percent was set after removing from consideration 290 billion rupees of the federal government's expenditure: the money it lends to provinces for financing their economic plans.
It was an independent commission that ordained that provincial governments raise the money directly from the market. Even so, the expenditure remains intact on the consolidated accounts of the federal and the state governments. A combined deficit of about 9 percent of GDP is what spooks rating companies like S&P, which rates India's local-currency debt below investment grade.
Without this accounting change, the federal deficit would, instead of falling to 4.3 percent, rise to 5.1 percent, D'Souza, the economist, estimates. A one percentage point jump in the deficit from last year just when rising interest rates are likely to push up the government's debt-servicing costs would mean asking to be hit by that oncoming train.
When it comes to paring deficits, Chidambaram isn't in a pause mode. He is actually rewinding the tape - not because he wants to, but because the Marxists won't have it any other way.
The proverbial light at the end of the tunnel for India's chronic budget deficits has turned out to be the headlight of an oncoming train. India's federal government announced this week that its most recent full-year deficit was 1.28 trillion rupees, or 4.1 percent of gross domestic product, the lowest since 1997.
Just three months ago, Finance Minister P. Chidambaram forecast the shortfall at 4.5 percent of GDP, unchanged from the previous fiscal year. He then said that deficit reduction, which is what investors and rating companies want the highly indebted Indian government to make its priority, was in a "pause" mode<!--QuoteEnd--><!--QuoteEEnd-->