The centre’s latest monthly finances statement doesn’t look pretty. Fiscal deficit for the first 5 months of the current financial year are already at 75% of the total budgeted amount. If this trend continues into the rest of the year, we are essentially looking at fiscal deficit that is almost double of that estimated in Budget 2013-14. For a country that has waged a long battle against inflation, often at the cost of economic growth, and continues to do so, this does not augur well. High inflation, essentially keeps interest rates propped up, and a high government deficit means more borrowings which also exerts upward pressure on interest rates, besides being inflationary.
While the government will likely resort to expenditure trimming in the next few months, the US government has an unintentional and definitely not the most desirable, but an out of the box solution to the problem. In a unique move, the US government has actually started shutting itself down, failing resolution on the budget for the financial year starting October 1, 2013. A shut down of the US government means that all but the most essential services will be stopped till such time that the impasse is resolved. These essential services cover defence services and social security. The services that will be affected include updates on crucial macro-data like the payroll numbers.
A US government shutdown will of course have multiple ripple effects for the US economy, stemming from a decline in government expenditure, which will ultimately impact growth in the economy, depending on how long the shutdown lasts. According to estimates by research firm IHS, quoted by a BBC report, the US government shutdown is costing it around US $ 300 million per day. The same report also points out to a Goldman Sachs estimate of a 0.9% reduction in GDP in this quarter on account of a shut down.
However, not all impacts of a government shut-down are negative. The fiscal deficit, for instance, will be positively impacted, even if it is not the most desirable manner of achieving a reduction in deficit. Now this might not be a possible solution for the Government of India, but that does not keep us from asking: What if? What if the centre actually shut down for a period of time? Will its fiscal deficit woes be resolved? Let us check.
In the past, the US government has shut down twice, once for six days in 1995 and then for 21 days in 1996. Based on this information, we build four scenarios for an Indian government shutdown – a shutdown of one day (the minimum), six days, twenty one days and 30 days (an entire working month).
Based on the number of working days in one year excluding weekends and gazetted holidays, we estimate the daily expenditure of the GoI. The number of working days that the government shuts down results in that much cut back in overall annual expenditure, is an assumption we make for the sake of simplicity. In the real world, there is a chance that some expenditures will have to be incurred at a later date even if they get postponed in the event of a shutdown.
The results from our estimations show that there can actually be pretty dramatic results resulting from a shutting down in the government. Needless to say, the longer the period of time we consider the shutdown, the deeper the impact because expenditure is not made for that many days more.
A 30 day or total of one month working day shutdown in the centre would result in as much as a 31% reduction of fiscal deficit from the amount estimated in the budget of 2013-14, with a 10% decrease in expenditure. In absolute terms, this means that the fiscal deficit will reduce by Rs 1,66,981 crore and will end the year at Rs 3,75,517 crore. This compares with a Budget Estimate (BE) of Rs 5,42,498 crore of fiscal deficit for 2013-14. A 21 day shutdown shaves fiscal deficit by over 21%.
This decline in fiscal deficit is due to a commensurate decline in expenditure, which is not made for all services except essential services. Like in the case of the US shutdown, we consider a continuation in expenditure on essential services, namely, defence and social-security related services. If there was a shutdown in total expenditure, the results would be even more drastic.
Even if we consider the shutdown for one day, it will result in a 1% reduction in fiscal deficit from the BE, and a 0.3% decrease in government expenditure. Similarly, if there is a shutdown of 6 days, there is a 6% decrease in fiscal deficit, and a 2% decline in expenditure.
Note that these estimates are only indicative, and not an exact amount of impact that will potentially take place if a shutdown were to happen. The greater the detail that we go into, the more precise the estimates can get. Also, we have considered only the first round impact of a potential shut down on the economy. Namely, the impact on expenditure and through that on fiscal deficit. In actual fact, though, there would be a second round impact of a shutdown. This is because, limited government expenditure impacts earnings of the individuals employed by the government. This in turn will potentially impact the demand for goods and services in the economy in a negative way as well and thus depress overall GDP growth. The actual second round impact will depend on the multiplier effect of government spending on the economy as well as the length of time for which such a shutdown takes place.
*Methodology: In order to arrive at the estimates for saving in expenditure over the 3 time periods under consideration we first estimated two figures:
(i) Central Govt. Expenditure ex-essential services expenditure: We worked with Budget Estimates of 2013-14. In the context of the US essential expenditure is that on social security and defence services. We used this description in the Indian context on the basis of heads that explicitly cover these expenditures. Defence services, is a clear head under the centre’s expenditure. For social-security we used figures for pensions where available under various ministries’ expenditures. The sum of defence services and pensions is the essential expenditure, which is subtracted from the total expenditure to arrive at the number for Central Govt. Expenditure ex-essential services.
(ii) Number of working days: These are estimated from the total number of days in one year less weekends, which is Saturdays and Sundays and Gazetted Holidays that do not fall on any of the weekends. The total number of days in the year less the total holidays gives us the total working days of 251.
Estimating cutback in central govt. expenditure ex-essential services
We divide the central govt. expenditure ex-essential services by the number of working days to arrive at the per day figure for the same. The per day figure is multiplied by the number of working days in a week and in a month to ascertain the cut back in central govt. expenditure ex-essential services on account of a potential shutdown.
We subtract the cutback from total expenditure budgeted for the year to assess the (i) actual decrease in expenditure and (ii) the impact on fiscal deficit. From here, we can determine the percentage impact as compared with the budget estimates.*
The story first appeared on IndiaSpend.