Government must show fiscal consolidation if India has to move forward
“The solution can not simply be massive debt monetization by the ECB. The solution must include credible, verifiable, and “enforceable” fiscal consolidation in various countries. Only then can the ECB agree to act as a bridge until the day that fiscal consolidation is implemented and is successful”.
The RBI should use this statement made by the ECB, which is saying that it is ready to act as the lender of the last resort but only on the condition that governments show credible fiscal consolidation. RBI has been consistently warning the government on its fiscal profligacy as it impedes the process of monetary transmission. However, despite warnings the government has steadfastly refused to implement any kind of reforms on food, fuel, fertilizer and power subsidies as well as making no progress in improving the tax to GDP ratio.
The result of lack of reforms on subsidies and taxes are telling on government finances. The government is set to fall short of its fiscal deficit target of 4.6% of GDP for 2011-12 by at least 1% and this will take the deficit to 5.6% higher than the 5.1% deficit seen in 2010-11. The states fiscal position is also getting into a mess with expected losses of Rs 100,000 crores of SEBs (State Electricity Boards) having to be borne by state governments. State government fiscal deficit will exceed the 2.2% of GDP projected for 2011-12 if the SEB losses are taken into consideration.
India’s total debt to GDP ratio at 65% (centre and state) is not anywhere close to levels of deeply troubled nations of Italy, Greece, Ireland and Portugal where debt to GDP ratios are higher than 115%. However, this does not mean that the government can stand up and say India has done a good job in managing its deficit. In fact India’s central government fiscal position has deteriorated considerably from levels of 2.55% of GDP in 2007-08 to current expected levels of 5.6% of GDP in 2011-12. The state government finances were in surplus until 2008-09 and it has now gone back into minor deficit.
The government has done nothing to usher in much needed reforms to keep its deficit under control. Subsidies as a percentage of GDP have gone up from 1.3% levels in 2006-07 to 2.08% levels in 2010-11. The rise of over 30 % in oil prices on a year on year basis as of end November 2011 is likely to take up the subsidy bill for 2011-12 to levels higher than 2.08% as there have been no pass through of rising fuel prices to the end user.
Gross tax to GDP ratio has remained in a 9% to 10% range over the last ten years and the government became myopic on tax reforms as tax collections improved due to GDP growth trending at 8.9% levels in the 2003-04 to 2007-08 period. The expected fall in growth rates for 2011-12 to 7.6% from 8.6% levels seen in 2010-11 will suddenly make the lack of growth in tax to GDP ratio stand out. Lower tax revenues in the face of a rising subsidy bill will turn government finances haywire.
The government is already facing the heat on its lack of fiscal consolidation. Bond yields had shot up by 60bps on the back of the government announcing a higher than expected borrowing program for the second half of 2011-12. Ten year benchmark bond yields touched multi year highs of 9% as markets fretted over bond supply. The RBI had to step in to buy government bonds in order to stabilise yields. Bond yields have since come off from 9% levels to 8.65% levels on the back of RBI bond purchases.
RBI cannot be buying government bonds indefinitely. RBI measures can only have temporary effect and for a more permanent effect on lower interest rates the government has to urgently usher in reforms on the expenditure and revenue front. Eurozone countries have realised the fickle nature or markets. When the going is good, markets fall over themselves to give money but when it gets bad, markets pull down economies.
India still has time to get its act in order. The hope is that the government wakes up to fiscal consolidation and if this can be achieved, the country will not look back.
