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‘Deficit Is Like A Cholesterol Problem’

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With less than a month to close the fiscal, economists have been scratching their heads over how — and how much — can the government contain the fiscal deficit for this year. Importantly, this being the only budget before the Election Commission's pre-election curbs kick in, the government is largely expected to dole out massive sops which will increase the burden on the exchequer. So, which way is India's balance sheet headed? There are, of course, a host of ‘what if' scenarios: What if the 2G auctions turn out to be a dud? What if disinvestment does not yield anything — yet again?  BW's Rajeev Dubey and Srikant Srinivas spoke to Ajit Ranade, chief economist at the Aditya Birla Group, on how to contain the widening fiscal deficit, revive investments and growth.


In the current fiscal, how responsibly, or irresponsibly, do you think the government has handled its finances?
Obviously, there has been a slippage. In terms of fiscal deficit, the expectation is that we will have a shortfall of one per cent of GDP which could be something like Rs 60,000 to Rs 70,000 crore. The shortfall has been on two or three counts. There has been over-optimism on disinvestment and global energy prices have been under estimated. In income tax or indirect tax, the shortfalls are somewhat lesser in magnitude. Also, clearly the subsidies on the oil bill are much higher. At the beginning of the year, we always make an estimate of what is going to be the average prevailing crude oil price globally. Then you make your calculations on the subsidies — of what we euphemistically call ‘under recoveries'. There, of course, the prices are much higher. The remarkable thing is that unlike the post-Lehman situation, where crude oil prices went from $140 all the way down to $35, before recovering. This time, after the recession, oil prices never went down. They remained at around $100. This has foxed not just the government, but many other people.

How much is the fiscal deficit likely to be?
About a per centage higher than predicted —about 5.6 per cent.

What is your projection for economic growth and deficit next year?
7.5 per cent (for GDP growth). Deficit, may be, 5 per cent.

What happens to the FRBM (Fiscal Responsibility and Budget Management) commitments?
We need to have the FRBM law because the commitment of the government otherwise lacks credibility. For example, a bunch of countries came together and signed the Maastricht Treaty — the basis of the EU.

One of the central conditions of the treaty was that nobody would breach fiscal deficit of 3 per cent of GDP. But the two largest economies in the EU — Germany and France — breached it. So FRBM sounded good when it was passed in 2003 but in the current global situation we need to find a different way to achieve credibility.

At what stage should one call fiscal deficit as unsustainable?
That is a difficult question. India has had high fiscal deficits for the past 20 years. And we have still had an average growth of about 6 per cent. India seems to be able to have a situation of co-existence of high fiscal deficit and high growth. Of course, one can always argue that the growth rate would have been even higher if the deficit was lower. Clearly, it's high. But if you look at what's in bankers' language called the debt-to-service ratio, on that count it looks even more horrible.

Fiscal deficit is like a cholesterol problem. Having a persistent level of cholesterol in your body is clearly harmful but you cannot fortell when you may have a heart attack.

Like cholesterol, fiscal deficit can be both good or bad. If you are running a fiscal deficit to create tangible, physical assets like infrastructure, or helping build future human capital, then that's good cholesterol. If it's not building assets, it's bad cholesterol. I would count health and educational spending as good cholesterol even though in accounting sense it is counted as revenue expense.

What can the government do before 31 March to salvage the situation, apart from the ONGC divestment that has been planned?
It is too late to try and fix it. C. Rangarajan has suggested that some public sector entities should buy stakes that banks disinvest. But if you want to fund the deficit, you need external money to come in. Disinvestment is like equity money. There are only two ways to bridge the deficit — you either tax or borrow. Borrowing is like taxing future generations. Personally, I think India will always have high deficits because of the nature of our democratic system. Democracies have an inherent deficit bias. It gets accentuated when you have a fractured polity where competing interests are many and diffused. The only saving grace we have on deficit reduction is our demography. The tax base will keep expanding. Our income tax collection has grown at twice the rate of GDP in the last 10 years, that is roughly at 25 per cent each year. Next year, we have two promises: 2G auction revenues and the backlog of this year's disinvestment, and more.
What's your view of the monetary policy right now? Is it likely to ease?
It will stay. They will do liquidity management only through CRR (cash reserve ratio).

How should the government prop up foreign investment?
Foreign investment will come. The Western world has so much liquidity that even if a tiny percentage comes to India, it will still be $10 billion. After the Lehman crisis, 2009 turned out the highest year for FDI in India with $35 billion. 2010 continued to be high at $30 billion. I am sure the number for this fiscal will also be respectable. So, if we get another $30 billion, that will be fantastic. I don't see why it won't come. Traditionally, FDI has preferred services to manufacturing in India. You can have more policies to enable that.

The biggest companies we talk about for disinvestment are the oil companies whose balance sheets have been weakened by the oil subsidies. How will it work?
All countries in the world either subsidise oil, or have some control on oil. Saudi Arabia gets 100 per cent of the oil revenues. In India, 57 per cent of revenues go to the government. In UK, it's 52 per cent. The lowest is probably the US — 35 per cent. Oil companies' disinvestment will depend on political management. But there are other companies to disinvest. All we are looking for is $5-6 billion. Disinvest-ment is always a fashion cycle, it's not a long-term phenomenon. Government capitalism is the big thing these days. We should just look for Rs 20,000-30,000 crore from there as non-tax revenues. There is the 2G auction. Some say, 2G can go to up to Rs 60,000 crore. So, between the two if you get Rs 1 lakh crore, that's 10 per cent of the budget.

Illustration: Champak Bhattacharjee

Does the government have the political capital?
The single biggest expense item on the budget is nearly Rs 4 lakh crore of interest, which is almost 40 per cent of all revenues. Interest is a non-negotiable, non-discretionary and inflexible amount. Nothing can be done to reduce interest obligation. Hopefully, when interest rates fall interest burden will come down. But that will happen only when deficit comes down. So, it's a chicken and egg situation. The second big item is defence expenditure and we cannot do anything about that either. What's left is a few thousand crore here and there. Our hope is on the scope for expenditure compression and increase in revenue. We have to find a way to expand the tax net and continue the momentum we have had on tax growth, without changing rates. If anything, they can come down. This budget is the last one before the election cycle kicks in. In that sense, there is an opportunity to take politically difficult decisions.

Can bank disinvestment shore up revenues?
There is not much scope as the government has stakes in the range of 51-55 per cent. You can have an FPO, but for that the government will have to bring in fresh equity. For every Re 1 you bring in, you can raise Rs 2, but you will have to bring in that Re 1. The government is currently in a very strange situation unless they go below 51 per cent. But that will be a huge step. The entire financial system works on one magic word called ‘trust'. And there has been a trust breakdown post-Lehman.

What is the ray of hope, apart from corporate growth that has been resilient?
The positives are that our exports, even in a bad year, continued to grow at 25 per cent in dollar terms. We can safely assume exports (which comprise 19 per cent of GDP) to continue to grow at 25 per cent. Nasscom is also very bullish. IT is a $100-billion industry. We talk about telecom revolution but telecom is not even 2-3 per cent of GDP. IT makes 6-7 per cent of GDP. The third positive comprises micro examples like the Delhi-Mumbai industrial corridor. The fourth positive is that India's consumption spending which is almost 60-70 per cent of GDP is steadily growing at 7-8 per cent. The consumer spending momentum should infuse confidence into the corporate sector to invest in fresh capacities.

How much of a worry is the widening trade deficit with China?
We should use it to our advantage. China has $3 trillion invested in bonds, most of that in US bonds, which are losing money. And they are stuck because the moment they try to sell these bonds, they will crash even further. Suppose we say, you invest only 1 per cent of that — $30 billion — into our infrastructure. We give a sovereign guarantee. We can say that we will give you 8 per cent returns. So, on one hand we have a trade deficit of $20 billion and on the other, we can get $30 billion this way.

(This story was published in Businessworld Issue Dated 12-03-2012)