Just as the government's Budget impacts the economy, the economy impacts the Budget. Expected gross domestic product (GDP) at current market prices (nominal GDP) is an important, but behind the scene, determinant of the Budget estimates. When actual undershoots expected GDP, tax receipts underperform, and the ratio of the deficit to GDP is worse than projected, fiscal marksmanship suffers.
Take for example 2002-03. India's Union Budget projected GDP at Rs 25.57 lakh crore. With poor agricultural outturn, by the time of the next Budget, the advance estimate (AE) of GDP for 2002-03 turned out to be 3.5 per cent lower. As a result, the revised estimate of fiscal deficit turned out to be 5.9 per cent of GDP against the budgeted 5.3 per cent.
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For several years, for the Budget, the finance minister applied a rate of growth of 12-14 per cent to the AE for the previous year to project GDP for the coming financial year. The only exception was 2009-10, when growth was assumed to be only 10 per cent. For 2015-16, with an assumed growth of 11.5 per cent, GDP was projected at Rs 141 lakh crore.
Much hangs on the AE of GDP for 2015-16. It will be released on February 8. Available data for the first half of the current year suggests that GDP for 2015-16 is unlikely to reach the budgeted figure. In the first six months of the current year, GDP growth was 7.4 per cent compared to 13.5 per cent in the previous year. To realise the GDP figure in the 2015-16 Budget, growth in the last half will have to be 17.3 per cent, a highly unlikely outcome.
Even if growth accelerates in the last six months from around eight per cent in 2014-15 to 10 per cent in 2015-16, GDP will not exceed Rs 136 lakh crore. The shortfall in GDP will increase the budgeted fiscal deficit, even without any slippage in the deficit in rupee terms, to 4.1 per cent of the GDP from the budgeted 3.9 per cent of the GDP. To deliver the promised 3.9 per cent, the finance minister will have to reduce the fiscal deficit figure from its budgeted level by at least Rs 15,000 crore.
Two questions arise in this context. First, should there be a relaxation of the path stipulated in the Fiscal Responsibility and Budget Management Act (FRBMA)?
Originally, the FRBMA stipulated elimination of revenue deficit and containing fiscal deficit below three per cent of GDP by end-March 2008. After eight years, the targets still elude India. The rolling three-year consolidation plans have been routinely flouted. The FRBMA was amended in 2012 to relax the objective of eliminating the revenue deficit to just containing it below two per cent of the GDP, and also to postpone the target dates for achieving the revenue and fiscal deficit objectives to March 2015 and March 2017, respectively. The Finance Bill, 2015, again postponed the target date for achieving the revenue deficit objective to March 2018. Frequent changes in plans cast serious doubts on credibility. It is now best to stick to the promised targets by appropriate adjustments in expenditure and revenue.
The second question relates to the deflationary trend manifested by the excess of GDP growth at constant prices over such growth at current prices in July-September 2015 and by the wholesale price index (WPI) in 14 months since November 2014. In the second quarter of the current year, the growth of GDP at current prices at six per cent was significantly lower than the corresponding growth at constant prices of 7.2 per cent. In each month during November 2014 to December 2015, the WPI has declined at an annual rate of 0.2-5.2 per cent. With deflation, is it time for the government to provide a fiscal stimulus?
Indeed there is the example of Japan still struggling to come out of deflation that started almost two decades ago with an asset bubble burst. In Japan, real GDP expanded by only 12.1 per cent between financial year 1997 and 2013, and nominal GDP in 2013 at ¥481 trillion was 7.6 per cent below the 1997 figure.
But with no history of sustained deflation, India suffers from entrenched inflationary expectations, and is no Japan.There have only been stray years of deflation in India in the past, e.g. after World War II in 1952-53, 1954-55, and 1955-56, in 1968-69 after two drought years, and in 1975-76 when inflation was tamed after the first oil shock. The signs of deflation observed in recent times are most likely a one-off development induced by the economy recovering from a phase of high inflation, helped by declining international commodity prices, particularly crude, and the pursuit of anti-inflationary monetary policy.
In each of the 14 months since November 2014, the consumer price index (CPI) has gone up by 3.3-5.6 per cent while the WPI has declined. Admittedly, the CPI and WPI measure prices of different things: CPI of final consumer goods and services (e.g. housing); and WPI of raw materials (e.g. crude petroleum), intermediate (e.g. nuts/bolts/screws and washers) and final goods. But, even then, is there a threat of the declining trend in WPI transmitting to CPI over time?
The literature is inconclusive on whether producer price index (not the same as, but a close cousin of, WPI) causes or leads the CPI. But, the bulk of the evidence supports causality from producer price index to CPI. However, inflation in CPI is still above five per cent in India. Even if the declining trend in WPI transmits to the CPI, it may only bring CPI-inflation down to a more moderate level, and not to below zero. By the time it does so, the international commodity price melt-down may be over, and the past increase in CPI may increase wages and hence labour costs. As a result, the deflation in WPI may end by the time the CPI starts moderating in sympathy with WPI. Too early to declare a war on deflation.
The writer is an economist
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