In their commitment to the Fiscal Responsibility and Budget Management (FRBM) Act, successive governments at the centre have done a good job at ensuring that the fiscal deficit to GDP ratio is not just kept in check, but also lowered overtime. As a result, from a level of 4.9% in 2012-13, the centre is now looking at a ratio of 3.5% in 2016-17.
The big question now is: Can the centre pull off another year of meeting the fiscal deficit-GDP target?
In any other year, the question would have had a ready answer: Yes. However, based on the developments so far in 2016-17, it is quite evident that this is not any other year. Three such developments are critical to determining whether the target can be met.
One, the ratio for the first half of 2016-17 stands at 6.3%. The number is generally significantly higher for the first half of the year as compared to the full year target, so this is hardly surprising. However, the number is slightly higher than the 5.9% ratio during the corresponding period of 2015-16. This indicates, that the deficit to GDP ratio will have to be lower during the second half of 2016-17 to compensate for the increase during the first half. It is not entirely impossible, though, since the year 2014-15 saw a 7.4% deficit to GDP ratio for the first half of the year, but still ended up at the 4% mark by end of the year, which was the same as in 2015-16.
Nevertheless, the trends for the first half, make it slightly harder to achieve the target as envisaged. This is particularly because the target itself has been 40 basis points lower than that during 2015-16, when it was at 3.9%.
Two, relatedly, in assessing how far it is possible to achieve the target, we at Orbis Economics projected three scenarios for the fiscal deficit ratio: optimistic, pessimistic and realistic. It turns out, that the target is achievable only in an optimistic scenario, while a pessimistic scenario, fiscal deficit to GDP ratio will be at around 4.1%, which is closer to the previous two years’ levels rather than the 3.5% level envisaged for 2016-17. However, the most likely is the realistic scenario, as per which, the centre’s fiscal deficit will close the year at 3.8% of GDP in 2016-17. This is an excess from 3.5% target set for the year, but is still a small improvement from the previous year, when the number stood at 3.9%.
Three, the estimates of both the centre and our own projections are based on GDP projections as released by the CSO’s advance estimates. This would have worked out just fine, except for the fact that in all likelihood, the impact of the demonetisation policy has not been factored in. Once projections for the policy move are factored in, real GDP growth will turn out lower than the 7% figure expected otherwise. As a result, even if the fiscal deficit number by itself remains unchanged, a lower GDP growth will inflate the fiscal deficit-GDP ratio. This, puts the possibility of achievement of the target in peril.
Even though we will only know the outcome for certain by the end of May 2017, by when both the final fiscal deficit and GDP numbers for 2016-17 will have been released, the developments discussed above raise another question as well:
Will the centre be able to stick to the 3% target set for 2017-18?
The question arises on account of two reasons:
One, our estimates indicate that there could be some slip up in fiscal deficit as a proportion of GDP, as elaborated above. If the ratio in fact comes in at 3.8%, and not 3.5% as initially envisaged; getting to a level of 3% by 2017-18, is closer to 1 percentage point away than 50bps away. In the recent past, a sharp reduction like this has not been envisaged in the budget estimates. In keeping with that perspective, it remains to be seen whether the government will change the trend, this time around.
Two, there could be an ongoing hit on the Indian economy on account of the demonetisation drive in 2017-18. While official figures on the estimated hit are not available, a bare minimum of 1 percentage point hit to economic growth is the consensus among a range of forecasters. In other words, we are talking a slip in growth to the whereabouts of 6% over the next year, which will make the 3% figure harder to achieve.
Based on these facts, it is reasonable to assume that the centre will revise the fiscal deficit-GDP revised estimate for 2016-17 and the budget estimates for 2017-18 upwards. In the event that it does maintain the original targets of 3.5% for 2016-17 and 3% for 2017-18; it would be worthwhile to watch for the fine print for additional sources of revenue and possible cuts to certain expenditures. The potential, on the revenue front, one off increases in the revenue kitty and cut backs on capital spends on the expenditure front need to be highlighted.
More trend analysis on data on government finances will be published in the next days.