Can primary deficit be yardstick for fiscal consolidation?

Planning Commission Deputy Chairman Montek Singh Ahluwalia wants the primary deficit, the fiscal deficit minus interest payments, to be the indicator of the health of government finances.

Ahluwalia recently wrote to Prime Minister Manmohan Singh, stating the primary deficit is the internationally accepted measure of fiscal consolidation because interest rates can vary for reasons other than government belt tightening. Finance Minister P Chidambaram had budgeted for a fiscal deficit--the broadest indicator of government overspending--of 4.6 per cent of the gross domestic product in revised estimates for 2013-14. The primary deficit was pegged at 1.3 per cent of GDP. The fiscal deficit overshot its target by 14.3 per cent a month before the financial year ended and the primary deficit was almost twice as high.

The revenue deficit, another narrow measure that tracks a government living beyond its current means, had by the end of February 2013 surpassed the target 3.3 per cent of GDP by 17.3 per cent. A big chunk of taxes and proceeds from stake sales by state-owned companies are due in March. This could keep the fiscal deficit within the original higher projection of 4.8 per cent of GDP made by Chidambaram in February 2012. The primary deficit will not be contained, though.

"Why should we not use both, the primary and fiscal deficits, as parameters for fiscal consolidation?" says Ajit Ranade, chief economist with the Aditya Birla group. "If the fiscal deficit goes down, government borrowings come down, which pulls down interest rates," he adds.

The Fiscal Responsibility and Budget Management Act sets no medium-term goals for the primary deficit, but the fiscal and revenue deficits have serially diminishing targets till 2016-17. The primary deficit is a better indicator of the government's fiscal position because it tells us something about debt sustainability, points out Devendra Pant, chief economist of India Ratings. When nominal GDP outpaces interest rates on government debt--the primary balance is surplus or a small deficit--the debt-GDP ratio falls, as it did between 2003-04 and 2008-09, he adds.

In their book Federalism and Fiscal Transfers In India C Rangarajan, chairman of the Prime Minister's Economic Advisory Council, and D K Srivastava, director of the Madras School of Economics, have recommended the primary deficit should be brought back into focus if debt has to be contained in proportion to the GDP. A primary surplus must be sustained for the debt-GDP ratio to fall, argue the authors.

The central government projects its outstanding debt, estimated at 46 per cent of the GDP in 2013-14, will come down to 44.8 per cent in the current financial year.