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Budgeting for India's deficits
February, 01st 2010

(D. H. Pai Panandiker is President of RPG Foundation. The views expressed in this column are his own)

By D. H. Pai Panandiker

Last year when the economy was showing signs of weakness from the impact of world recession, the splurge in expenditure by government and the huge budget deficit that followed were justified.

These, in fact, stopped economic growth from slipping below 6 per cent. Whether this bloated deficit should continue in 2010-11 is however questionable.

Fiscal deficit has its own price. Ultimately, it results in higher interest rates which discourage private sector from investing and induces inflation which hurts more the poorer sections of society. Excessive budget deficits also lower countrys credit rating in the international market and necessitate payment of higher interest rate on external borrowings.

The deficit that is more harmful is the deficit on revenue account since it transfers, to that extent, the savings of the public into consumption of government.

The central government had brought it down to 1.1 percent in 2007-08. It will jump to 4.8 percent in the current year. This apart, the state governments will generate their own budget deficits as well.

The bloated deficit is due to both a fall in revenue as also an increase in expenditure. The tax revenue in the current year has dropped by 7.5% mainly on account of the 6% cut in excise duties and 2% cut in services tax. As a result, indirect tax revenue shrunk 23%.

The increase in fiscal deficit is entirely due to expenditure expansion. More than 80% of the Rs.4.01 trillion deficit now consists of expenditures on subsidies and interest payments which eat up 72% of the net tax revenue of the central government.

Recession is now an old story. Almost all countries have recovered though it may take some time before they fully normalize. The Indian economy is on the bounce with industry crossing 10 per cent growth. The only problem that stares in the face is inflation and a high deficit is not a good prescription to bring it down.

It is important therefore that the next budget becomes the starting point for corrective action.

The next budget should endeavour to improve revenues and curtail expenditures. Some of the stimulus measures which were initiated earlier will have to be trimmed to generate additional revenues. That is true of excise duties and service tax. More than that, it is imperative that expenditures are sliced off, more particularly non-productive expenditures like subsidies.

It is the deficit on revenue account that should be the first to be reduced. But this reduction should not come from the proceeds from sale of public sector undertakings. For, this money is capital receipt and should be used for capital expenditure.

The endeavour should be to reach zero revenue deficit as required by FRBM Act possibly in two years. The 2010-11 budget should therefore target revenue deficit at 2.8 per cent.

That will create a better environment for growth. The government will borrow less and avoid over-crowding on the capital market which will stabilize interest rates and check interest liabilities of government while stimulating private investment.

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