Fiscal deficit breaches FY18 target: Why its rise is bad for India's economy

Increasing government spending to spur the economic growth has often evoked varying opinions on its consequences. While the jury is still out on the after-effects of a policy where the government loosens its purse strings to prop up demand, the move could make an interest rate cut by the central bank more elusive.

The government's plan to raise additional market borrowings of Rs 50,000 crore through dated government securities has left too much room for a fiscal slippage. The move, which is being seen as a way to meet the revenue shortfall on account of lower tax collection under the GST, may put a spanner in government's fiscal consolidation path.

This comes after GST collection numbers for November witnessed a continuous decline for the second straight month. The Controller General of Accounts (CGA) data on Friday revealed that the governments revenue receipts were at Rs 8.04 lakh crore till November, which work out to 53.1 per cent of the budget estimate of Rs 15.15 lakh crore for 2017-18.

Experts have predicted that fiscal deficit, the difference between government's total revenue and total expenditure, is likely to shoot up by 30 basis points in the current fiscal. A breach of fiscal discipline may affect India's sovereign ratings besides hurting the confidence of foreign investors. Modi government recently got a thumbs up from credit ratings agency Moody's when it upgraded India's rating from the lowest investment grade of Baa3 to Baa2.  

Country's benchmark 10-year bond declined to a nearly 17-month low, pushing its yield up by as much as 17 basis points a day after the government announced additional borrowing for the year ending in March, surpassing the market expectations. The slump in bond prices and the rise in yields may trigger a sell-off in the debt market.

Moreover, India's fiscal deficit till the end of November has already breached the target and touched 112 per cent of the budget estimate for 2017-18 due to higher expenditure. According to the data released by the CGA, the fiscal deficit in absolute terms was Rs 6.12 lakh crore during April-November 2017-18. 

In a research note, Bank of America Merrill Lynch said, "the additional borrowing of Rs 50,000 crore by the Centre is a "negative surprise" that will sustain higher yields and delay lending rate cuts, key for economic growth recovery."

Finance Minister Arun Jaitley, on several occasions, has said that his government is committed to 3.2 per cent fiscal deficit target for 2017-2018. There are ample reasons for the government to adhere to a tight fiscal policy.

High fiscal deficit
Higher government expenditure will push up demand and generate more money in the economy. This may lead to higher inflation.

Taxes
High fiscal deficit means government is not able to earn as much as it is spending. So often it raises taxes in some form or the other. The government, in order to repay its debt, is likely to levy more taxes in the future. It could be either higher inflation or higher taxes. Or, worse, it could be both.

Interest Rates
In an emerging economy like India, a higher fiscal deficit leaves little room for interest rate cuts. A higher interest rate may affect private investments from taking off in a growing economy like India. Banks have already witnessed a slowdown in credit takeoff.

Borrowing costs may remain high for consumers (vehicle and house purchases or personal loans) and industry/companies

Private sector
More than average borrowing by the government from the market leaves that much less pool for private sector to borrow, stalling its growth plans.

Fiscal constraints during crisis
It reduces the options for a country to recover from an unforeseen economic volatility like the financial crisis that hit the world in 2007-08. After the fiscal stimulus package post 2008 market crash, India's fiscal deficit jumped to about 6 per cent of the GDP.