Fiscal glide path, to change or not – Jaitely’s dilemma

Having stuck to the fiscal consolidation road-map for three consecutive years beginning 2014-15 and put up a brave front in regard to remaining on course during the current year at least until recently, finance minister has now alluded to what he termed as ‘changing the glide path to meet the challenges emerging from structural reforms’. The statement was made at Morgan Stanley investor meet in Singapore.

However, in the wake of Moody’s Investors Service revising India’s sovereign rating from Baa3 to Baa2 and outlook from ‘positive’ to ‘stable’, Jaitely has retracted from the above and exuded confidence that the government will stick to fiscal consolidation road-map. Yet, it is necessary to analyze the reasons for his discomfiture and assess whether he would be able to achieve the set target.

During April – September 2017, government has already incurred 91.3% of fiscal deficit target [3.2% of GDP] as against 83.9% during April – September 2016. With 6 months still to go and not keen to compress the expenditure on the capital side [needed to maintain the tempo of growth in the face of continuing sluggishness in private investment] and social welfare, it has very little room to maneuver.

But, the big worry for Jaitely is massive recapitalization of public sector banks [PSBs] by Rs 211,000 crores in two years viz. 2017-18 and 2018-19 and a major rehash of GST [Goods and Services Tax] undertaken by GST Council on November 10, 2017 which is estimated to cause revenue loss of about Rs 20,000 crores.

To fund capital injection, the government intends to raise Rs 135,000 crores from ‘recapitalization bonds’, Rs 58,000 crores from the market and Rs 18,000 crores as budgetary support. The last bit has already been factored in under the project ‘Indradhanush’ [launched in 2015] for infusing Rs 70,000 crore over 4 years. Of this, Rs 50,000 crores were given during 2015-16 and 2016-17 and balance Rs 20,000 crores is to be provided during current and next year. But, the other two sources pose a daunting challenge.

A sum of Rs 58,000 crores is to be raised from the market by reducing government’s equity holding in PSBs to 52%. However, considering their weak balance sheets [courtesy, high non-performing assets (NPAs)], buyers are unlikely to pick up stakes. There is a further dis-incentive on account of the fact that even after divestment, the government will continue to have majority ownership and hence, full control on how these are run.

As regards ‘recapitalization bonds’, these will be issued by union government and most likely subscribed to by state-run financial institutions such as Life Insurance Corporation [LIC]. So, there won’t be any immediate cash outflow though interest payments will make recurring dent on the budget. But, given the huge amount involved, a good portion of this may remain un-subscribed despite support from government owned institutions which itself is not a healthy practice.

Any shortfall under these two heads will have to be made up via additional budgetary support. This injection of funds cannot be deferred either as RBI mandated strict provisioning requirements – exacerbated by proceedings against defaulting borrowers under the Insolvency and Bankruptcy [IBC] code – has led to huge erosion in the capital of banks. Clearly, recapitalization cannot wait.

According to Fitch Ratings, PSBs would require 90% of $65 billion additional capital needed by banks in India to meet Basel III capital standards which will be fully implemented by financial year ending March 2019. This works out to Rs 380,000 crores and is necessary to raise loan growth, address weak provision cover and aid in effective NPAs resolution. Against this, the government has so far endeavored to cover Rs 261,000 crores [211,000 crores plus 50,000 crores already given]. So, there will be a further gap of Rs 119,000 crores.

As regards GST, with 4 months already passed, the revenue garnered has been below expectations. In fact, during July – September, in all the three months almost all the states reported revenue loss vis-à-vis what they would have got under the subsisting dispensation. And now, with over 200 items shifted to lower slabs [of these, a whopping 180 have been moved from highest 28% to 18%], a further jolt to revenue collection is in the offing.

GST was intended to give a boost to GDP and together with bringing in millions of businesses earlier out of the tax net, result in huge buoyancy in tax revenue. But, these gains have been nipped in the bud by adopting a complex architecture viz. multiple slabs [rates] 0, 3%, 5%, 12%, 18%, 28% plus cesses on de-merit items and insisting on filing monthly returns; instead of a ‘Good and Simple Tax’ [to use the phraseology of Modi] and hassle free compliance which was needed.

The recent rationalization on November 10, 2017 may have given some relief to affected consumers and businesses [albeit small] but complexities in the architecture remain and unlikely to go away too soon. Therefore, any possibility of tax mop-up improving drastically looks remote. Meanwhile, any big gain by way of tax and penalty on huge cash deposit – post-demonetization [November 8, 2017] – is unlikely during the current year [perhaps, next year too] as this has to go through a long-drawn process of sending notices, passing assessment order and payment.

A third area wherein the government may not achieve the target is proceeds of divestment. Against an estimate of Rs 72,500 crores, so far it has realized only Rs 27,000 crores [mostly from sale of its stake in public sector insurers]. Even after taking credit of about Rs 30,000 crores that sale of its 51% holding in Hindustan Petroleum Corporation [HPCL] to Oil and Natural Gas Corporation [ONGC] will fetch [subject to this sale getting consummated within this year], there will still be a shortfall of Rs 15,000 crores.

Fourth, the recent spurt in the price of crude oil due to OPEC [Organization of Petroleum Exporting Countries] sticking to cut in supplies and internal upheavals within Saudi Arabia – lead exporter in middle east – to US$ 60 per barrel and possibility of its touching US$ 65-70 per barrel, may cause spike in subsidy on petroleum products much beyond budgeted level of Rs 25,000 crores. This will also push up subsidy on fertilizers where the price of feedstock/raw materials and even finished product is linked to movement in the price of oil. The impact will be more pronounced during 2018-19.

Finally, the ability of the government to maintain fiscal discipline during last three years has rested a lot on deferring fertilizer and food subsidy payments – in thousands of crores – year after year. This is nothing but ‘financial engineering’ [a legacy from times of UPA] resorted to by Team Jaitely to make its fiscal math look good. This is being continued during current year [perhaps, next year too]; but for this the situation may turn even more unmanageable.

In view of above, the discomfiture of finance minister [expressed in Singapore] has valid basis. No wonder, he might still allow some slippage in fiscal deficit for 2017-18/18-19 and justify in terms of the leeway offered by NK Singh Committee on FRBM [Fiscal Responsibility and Budget Management]. It allows government an escape clause to breach the targets in case of “far reaching structural reforms with unanticipated fiscal implications”.

Nonetheless, Modi – dispensation will need to do a lot more to stick to the glide path as mooted by the Committee i.e. fiscal deficit at 2.5% and debt-to-GDP ratio of 38.7% by 2022-23.

 

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