Facing a debt trap

The budget for 2011-2012 is arguably the most important that any government has presented since the heady days of economic liberalisation after the 1991 crisis. Pranab Mukherjee described it as a budget of transition, in which the government, having administered a sharp fiscal stimulus to the economy to get it out of recession, begins its return to ‘normal,’ more conservative economic management. This correction is essential, but it is not the reason for its importance.

This budget derives its significance from its candid admission that India is sinking deeper every year into a debt trap, and from its detailed discussion of the policies that will have to be adopted to reverse this descent. The debt trap had been looming at the end of the fiscal road for some time: in 2007-08 , before the global recession, the ratio of  India’s national debt to its GDP was already a shade over 70 per cent. Although this was high, thanks to a slow but steady reduction in the fiscal deficit of the Centre and the states in the previous five years, the ratio had almost ceased  to rise.

But this changed dramatically in 2008-09. The so-called fiscal stimulus of 2008 — in reality a host of giveaways to powerful interest groups that  had been decided long before the onset of the global recession — pushed the consolidated fiscal deficit of the Centre and the states up from 5 per cent of the GDP to 10.2 per cent. And this was a far higher rate of increase than that of the GDP. As a result, the debt to GDP ratio rose swiftly to 73.1 per cent in 2008-09 and to 75.4 per cent in 2009-10.

Every increase in this ratio increases the proportion of revenues that the Centre and states have to set aside to meet interest payments, and consequently squeezes their power to spend on actual governance. Today almost half of the Central government’s tax revenues are being pre-empted by the need to service the national debt.

This trend has not only to be stopped but reversed. The virtue of the current budget is that it has candidly admitted this, albeit not in the stark terms outlined above, and also spelt out a policy for doing so. The admission and policy suggestions  are not to be found in the finance minister’s budget speech, which remains anodyne and self-congratulatory, but in the Fiscal Policy Strategy statement that he  also unveiled while presenting the budget.

The Fiscal Policy statement  is the first such document to be released alongside a budget since the Long Term Fiscal Policy statement of prime minister Rajiv Gandhi and finance minister V P Singh in 1987. It candidly admits that the gap between the Central government’s expenditure and its tax revenues has nearly doubled from 3.2 per cent of the GDP in 2007-08 to 6.2 per cent of GDP in 2009-10. In absolute terms the government spent Rs five in 2009-10 for every Rs three it earned.

Deficit

The Statement has made it clear that this is not a sustainable deficit and, that since it has already cut its capital expenditure (investment) to less than one sixths of revenue expenditure (consumption), this gap cannot be bridged without reigning in the latter.

This is not the first time that a government has promised to cut its consumption. Indeed this has been a hardy annual since the mid-70s. What distinguishes the present commitment is that it formalises an effort that is already under way. In the middle of the current fiscal year the government quietly lifted price controls on gasoline and diesel. This has already begun to make a dent in its subsidies on petroleum products — a dent that is reflected, albeit somewhat optimistically in its estimate that these subsidies will fall from Rs 38,386 crore this year to Rs 23,640 crore in 2011-12.

However, the budget estimates Mukherjee presented show that India is far deeper inside the debt trap than most people realise and that it will take far more than a sharp reduction of oil and fertiliser subsidies to put the economy back on an even keel.

The budget data show that the Central government’s total expenditure was 2.15 times its tax revenues in both 2008-9 and 2009-10. If this ratio remains unchanged in 2011-12 actual expenditure will be of the order of Rs 14,27,000 crore in 2011-12 and not Rs 12,57,729 crore estimated in the budget. There is nothing in either the budget or the fiscal policy statement to show how the government hopes to achieve such a large reduction.

The answer, that Mukherjee has hinted at but not stated is that continued high growth will push up the rate of growth of tax revenues in 2011-12. The sharp industrial recovery during the second half of last year and the first half of this year  caused a 23 per cent jump in tax revenues.

But will GDP grow by nine per cent next year? Even a cursory examination of the trends in the economy shows that it cannot. Agriculture is slated to grow by 5.4 per cent this year but only because of a rebound from last year’s unprecedented drought. Even an excellent monsoon will not permit more than a two per cent growth this year.

Slower growth means an even slower growth of tax revenues. Thus the RBI is making sure that India will continue to sink deeper into a debt trap in the coming year.