The Government of India has aimed to closely watch on the spending in order to complement RBI’s measures for controlling inflation and manage external account amid capital outflows. In February 2022, Prime Minister Narendra Modi’s Government Set a fiscal deficit target of 6.4% of Gross Domestic Product compared to 6.7% last year.
Before we get in to the topic lets discuss what is Fiscal Slippage?
- Fiscal Slippage in simple terms is any deviation in expenditure from the expected. For example let’s say a trader wishes to buy a certain stock at Rs.10 and 1000 in number.
- In this case there are market forces such as demand and supply involved i.e. Liquidity in the stock or volumes traded in it as well as the intermediaries in the chain.
- So, there is likely a chance that the trader is able to secure some of the outstanding shares of the company say 500 at Rs.10 while secure the remaining at Rs.15 due to intermediaries who influence the price of a stock to a significant degree.
- This is what is referred to as fiscal slippage. On a larger level, say the central government when the government’s expenditure surpasses the expected or estimated levels it is the fiscal slippage threat that the country then reels in.
What is Fiscal Deficit?
- Fiscal deficit, the condition when the expenditure of the government exceeds its revenue in a year, is the difference between the two.
- Fiscal deficit is calculated both in absolute terms and as a percentage of the country’s gross domestic product (GDP).
- The fiscal deficit of a country is calculated as a percentage of its GDP or simply as the total money spent by the government in excess of its income.
- In either case, the income figure includes only taxes and other revenues and excludes money borrowed to make up the shortfall.
How is fiscal deficit balanced out?
- While a rising deficit is a challenge for the government in the long term, to balance it out in short-term macroeconomics, the government looks at market borrowings by issuing bonds and selling them in through banks.
- Banks buy these bonds with currency deposits and then sell them to investors.
- Government bonds are considered an extremely safe investment instrument, so the interest rate paid on loans to the government represents risk-free investment.
- The government also sees a deficit situation as an opportunity to expand policies and schemes, including welfare programmes, without having to raise taxes or cut spending in the Budget.
Inflation and India
- Surging costs forced India in May to cut fuel taxes and change duty structures hitting revenues by $ 19.6 billion while additional fertilizer subsidies lifted expenditure.
- The Government and central bank have scrambled to contain prices through fiscal measures and monetary tightening after inflation jumped to multi year high.
- Retail Inflation has held above the Reserve Bank of India 6% mandated ceiling for five straight months while wholesale price inflation has risen to 30 year highs.
- The fiscal deficit for FY23 is seen at ₹16.6 lakh crore, or 6.4% of GDP. The government faces a spike in food and fertilizer subsidies and had to reinstate support for cooking gas to shield consumers.
- On the revenue side, it took a hit due to the cut in excise on petrol and diesel to reduce soaring fuel retail prices. The higher expenditure and lower revenue had raised concerns that the fiscal slippage could stoke inflation, undermining efforts by the RBI.
- Consumer inflation has eased from the eight-year peak of 7.8% in April to 7% in June but has stayed outside RBI’s 2-6% target range for six consecutive months.
How Inflation has effected India?
- The war between Russia and Ukraine has caused a disruption in global supply chain, thereby pushing up prices of crude oil and other commodities. The spillover effect is now being felt by all economies of the world.
- All this at a time when economies are trying to put behind the slump induced by the Covid pandemic and are gradually trying to increase the pace of growth. Crude oil prices had mostly been on rise in March, after Russia started the invasion of Ukraine on February 24.
- Oil companies in India had begun passing on the high import cost of global crude oil prices by hiking domestic petrol and diesel prices from March 22 — after a four-and-half-month long hiatus.
- Besides, domestic cooking gas (LPG) prices were also hiked during the month.
India is dependent on imports to meet 85 per cent of its oil needs and so retail rates adjust accordingly to the global movement.
- In March, inflation in crude petroleum spiked to 83.56 per cent, from 55.17 per cent during February.
Impact on households
- As producers grapple with high input costs, firms have started passing on higher prices to consumers.
- Rising input costs for products such as fuel, metals and chemicals have pushed up wholesale prices, a proxy for producer prices and are adding to pressure on retail prices.
- However, the impact of rising inflation will vary widely across households owing to the difference in consumption patterns.
- In the past few months, prices of almost all essential items have seen a surge, thereby forcing the common man to revisit his/her household budget.
- The spillover effect of soaring fuel prices has in effect made transportation expensive.
- This has added to the woes of people who now buy their regular food items at a much higher price than a year ago.
Soaring prices = Fall in savings
- Apart from prices of staples, households will also feel the pinch if RBI indeed opts to raise interest rates in the near future.
- If at all the central bank opts to hike interest rates, it will put an upward pressure on a household’s monthly expenditure as the amount of equated monthly instalments (EMI) that people pay for loans will rise.
- To be clear, let us explain this via the following example:
- Assume a person is paying an interest of 7 per cent on a principal amount of Rs 50 lakh for a tenure of 20 years. The EMI amount comes out to be Rs 38,765.
- Now, if RBI raises rates by 50 basis points (bps) to 7.5 per cent, the EMI amount shoots up to Rs 40,280.
- In case of a rise of 100 bps to 8 per cent, it amounts to Rs 41,822.
Ways to manage fiscal slippages in Economy
- Expenditure should be done as far as possible in line with planned and judiciously such that it is not faltered at very widely.
- Disinvestment is another way out to come out of the slippage.
- Proceeds from revenue collection to be used towards promoting economic sectors and in turn create jobs and likewise enhanced production and consumption.
- Subsidy cut down to judicious level.
- Tax mechanism should also be such that it does not create any kind of fear while settling their tax dues.
Expenditure Control Measures by Government
- The government decided to cut part of excise duty levied on petrol and diesel.
- This reduction is estimated to bring down revenue collection by ₹1-lakh crore.
- At the same time, subsidy on fertilizer has been raised by ₹1.10-lakh crore to ₹2.15-lakh crore.
- All these are expected to have an effect on the fiscal deficit, indicated a monthly economic review (MER) prepared by the Economic Affairs Department of Finance Ministry.
- As government revenues take a hit following cuts in excise duties on diesel and petrol, an upside risk to the budgeted level of gross fiscal deficit has emerged.
- Increase in the fiscal deficit may cause the current account deficit to widen, compounding the effect of costlier imports, and weakening the value of rupee, thereby further aggravating external imbalances, creating the risk of a cycle of wider deficits and a weaker currency.
- Rationalizing non-capex expenditure has thus become critical, not only for protecting growth supportive capex, but also for avoiding fiscal slippages
- The budget prescribed an expenditure of over ₹39.44-lakh crore, out of which capital expenditure has been estimated at over ₹7.50-lakh crore, while the remaining ₹32-lakh crore is revenue expenditure.
- India faces near-term challenges in managing its fiscal deficit, sustaining economic growth, reining in inflation and containing the current account deficit while maintaining a fair value of the Indian currency.
- Many countries around the world, including and especially developed countries, face similar challenges.
- India is relatively better placed to weather these challenges because of its financial sector stability and its vaccination success in enabling the economy to open up.
- India’s medium-term growth prospects remain bright as pent-up capacity expansion in the private sector is expected to drive capital formation and employment generation for the rest of this decade.
- Near-term challenges need to be managed carefully without sacrificing the hard-earned macroeconomic stability
- In the medium term, the successful launch of the Production Linked Incentive (PLI) scheme, development of renewable sources of energy while diversifying import dependence on crude oil and strengthening of financial sector are expected to drive economic growth.
- The high-wire balancing act between maintaining growth momentum, restraining inflation, keeping the fiscal deficit within budget and ensuring a gradual evolution of the exchange rate in line with underlying external fundamentals of the economy is the challenge for policymaking this financial year.
- Successfully pulling it off will require prioritizing macroeconomic stability over a near-term growth. The reward for such a policy discipline will be the availability of adequate domestic and foreign capital to finance India’s investment needs and economic growth that fulfil the employment and quality of life aspirations of millions of Indians.
- With the current FY likely to end with FD of 7.4 percent – against the target of 6.4 percent – the government won’t be able to stick to even this substantially relaxed fiscal trajectory.
- This is dangerous as it will lead to an increase in Centre’s debt to unsustainable levels. Already, it has climbed to 62 percent of GDP against 46 percent set by Singh committee The Government should make efforts to avoid this horrendous scenario.
- Even as Modi dispensation is doing its best to increase tax collection and the momentum should be maintained, there is an urgent need to rein in
- Expenses, particularly on welfare schemes. Here, substantial savings are possible by restricting coverage, cutting costs, improving efficiency and minimizing leakages.