IMA Analysis

Friday October 4, 2019

Deficit Risks

Author:  Adit Jain,Editorial Director, IMA India

Risks in indicators

Key economic indicators are measured as a percentage of GDP, because that is the most appropriate way of giving them a context. These include government spending, tax collections, trade and current account imbalances (deficits usually for India) and, most significantly, the fiscal deficit. Analysts look at these figures to determine the intrinsic health of a country’s economic architecture; rating agencies base their outlook on them and foreign portfolio investors allocate capital on such scores.

In her budget presentation to Parliament, in February this year, Finance Minister Nirmala Sitharaman reassuringly declared that the fiscal deficit would be maintained at 3.3% of GDP. Obviously, the treasury recognises the fact that high deficits worry investors and crowd out private capital. Government spending, although necessary, is terribly inefficient with a lesser impact on economic output than the more productive private sector variety. But the fiscal deficit is really only a part of the plot. It can be manipulated by keeping borrowings off the books in order to comply. For instance, governments have over the decades used public sector enterprises to raise funds on their behalf, through debt or bond offerings. The most active in such transactions are the Indian Railways and the Food Corporation of India, whose debt is hurriedly subscribed to, despite the fact that they are structurally frail. Investors and banks seek comfort in the assumption that such institutions are really government with a negligible risk of default. Such off-balance sheet borrowings are to the tune of approximately Rs 1.5 trillion, or 0.7% of GDP.

Then State governments too, borrow. Frankly, many are so indebted that no sensible investor would hastily subscribe to their bond offerings unless at exceptionally high yields to reflect their consequential risk. But in India, that is not the case. Investors equate debt offerings by provincial governments as near sovereign and mistakenly believe that they have the explicit backing of the central government. That is really not true. If such bond offerings were priced correctly, state governments would be more sensible in their spending habits.

Indian sovereign paper is rated investment grade or just about. The fact is several countries that seem economically more irresponsible, appear to get away with better ratings. These include many with huge pension liabilities where their governments have no clue as to where the money to honour them will come from. Why is it then that agencies fail to provide India with better scores? The answer is they look at other parameters including national dissaving rather than the more simplistic fiscal deficit. Their calculations consider the debt of the central government; those of its enterprises; state governments and their business undertakings and finally municipal and local authorities. All such liabilities add up to an alarming 6.5-7% of GDP.

A crucial figure still remains the fiscal deficit. The budget papers, as previously mentioned, placed this at 3.3% of GDP but on the explicit assumption that the economy would grow at 8%. This target now appears unfeasible, as real growth is likely to be well below this figure, perhaps closer to 6%. Moreover, the recent cut in the corporate tax rate will reduce revenue by up to Rs 1.5 trillion, or 0.7% of GDP. Consequently, assumptions may go awry, forcing agencies to revise their outlook; certain funds to reconsider their positions and even exit India’s financial markets. That would put pressures on the currency, drive inflation and create liquidity nightmares. Whether the tax cut is sufficient to compensate for these factors remains to be seen. For now risks ahead are weighted a little to the downside. 

Adit Jain’s articles and opinions can be found on his blog at This content is the intellectual property of IMA India and is copyright protected and legally privileged. Unauthorised copying, reproduction or distribution of this information would amount to an infringement of law and would invite applicable penalties.