Deficit dogs Mukherjee, as it did Manmohan

A widening fiscal deficit was one of the biggest concerns for Manmohan Singh as he presented on July 24, 1991, what is now acknowledged universally as independent India’s first reform Budget.

Singh’s predecessor, Madhu Dandavate, had allowed the Union government’s fiscal deficit to reach an unsustainable 8.4 per cent of gross domestic product (GDP) for 1990-91. In his Budget speech for 1991-92, therefore, Singh proposed to bring that down to 5.78 per cent.

Almost 19 years later, Finance Minister Pranab Mukherjee’s concerns do not appear to be very different. Thanks largely to the generous doses of stimulus measures in the last 15 months to revive a slowing economy, the government’s fiscal deficit is expected to be as wide as 6.8 per cent for 2009-10, compared to 6 per cent in the previous year.

For Mukherjee, who will present his second Budget under the United Progressive Alliance government on February 26, to go with the three he presented in the 1980s, one of the main challenges is to bring down the fiscal deficit for the next year to 5.5 per cent, a target he set himself last year.

Indeed, the Union government’s fiscal deficit story in the last 19 years is one of steady and gradual correction over the first seven years, a reversal of that trend in the following four years, a return to the path of fiscal correction for the next six and then a sharp deterioration in the last two years (see chart).

Yes, the long-term trajectory showed a decline as the government’s fiscal deficit came down from 8.4 per cent of GDP in 1990-91 to 2.7 per cent in 2007-08, but it rose sharply to 6 per cent in 2008-09 and to 6.8 per cent in 2009-10 (Budget Estimates), reviving for Mukherjee concerns that also bothered Singh almost two decades ago.

Similarities between the concerns of Mukherjee and Singh, of course, do not end here even though the two exercises are separated by almost 19 years and the period in between has seen economic reforms growing deep roots.

Take a look at government subsidies and their growth as a percentage of GDP over this period. Singh’s first Budget in 1991-92 made a valiant attempt at reducing subsidies to 1.88 per cent of GDP, compared to 2.14 per cent in 1990-91. Over the next 16 years, their growth remained under check at around the same level even as all attempts to reduce them failed.

But in 2008-09, they shot up to 2.43 per cent of GDP. Worse, these did not include a large element of hidden subsidies to the oil sector that could not be captured under this head because of the manner in which oil prices were administered. Mukherjee, who had promised to keep subsidies down to 1.9 per cent of GDP in 2009-10, now has the unenviable task of keeping subsidies down even while implementing the 13th Finance Commission’s recommendation to switch over to a more transparent method of doling out subsidies to the oil sector — a move that will make his subsidies look even more bloated.

The government’s capital expenditure, which largely captures investments in productive assets, also continues to be an area of concern, though no finance minister in this period managed to address it effectively. Dandavate had kept the government’s capital expenditure at 5.6 per cent of GDP in 1990-91. This began declining since that year to 1.83 per cent of GDP in 2008-09. Mukherjee tried to reverse the trend by raising it to 2.1 per cent in 2009-10. However, the government’s total expenditure has maintained a 17 per cent plus share in GDP over these 19 years. In other words, the government’s revenue expenditure (largely on wages, subsidies and defence) has seen a sharp rise from 13 per cent of GDP in 1990-91 to over 15 per cent this year.

A major achievement of the last 19 years of Budgets has been the steady rise of direct taxes as a percentage of GDP, which Manmohan Singh raised to 2.33 per cent in 1991-92 and further went up to 6.32 per cent in 2009-10. In sharp contrast, indirect taxes declined from about 8 per cent of GDP in 1991-92 to 4.63 per cent in 2009-10. With tax reform proposals put on hold for at least a year (both the Direct Taxes Code and the Goods and Services Tax, slated to be introduced only from April 2011), the challenge for Mukherjee is how to further improve this ratio between direct and indirect taxes.