No restraint on revenue deficit yet

Finance Minister Pranab Mukherjee may have earned plaudits for projecting a decline in the fiscal deficit to 5.5 per cent of gross domestic product (GDP) for 2010-11, but his targets for revenue deficit reduction are relatively modest and represent a departure from the 13th Finance Commission's recommendations.

Mukherjee’s Budget for 2010-11 proposed to reduce the fiscal deficit from 6.9 per cent (including the impact of oil and fertiliser bonds) in 2009-10 to 5.5 per cent next year, lower than even the 5.7 per cent mandated by the 13th Finance Commission.

But the revenue deficit has been pegged only at 4 per cent of GDP in the Budget for 2010-11, down from 5.3 per cent according to the revised estimates for the current financial year. In sharp contrast, the Commission had recommended a reduction in the revenue deficit next year to 3.2 per cent of GDP.

Fiscal deficit is the difference between the government’s total expenditure and total receipts without borrowings. Revenue deficit shows the excess of the government’s total revenue expenditure (largely on non-asset creating schemes, subsidies, salaries and pensions) over its tax and non-tax revenues.

The 13th Finance Commission had recommended revenue deficits of 2.3 per cent and 1.2 per cent of GDP for 2011-12 and 2012-13, respectively. The finance ministry’s medium-term fiscal policy statement indicates that the revenue deficit for these years would come down to only 3.4 per cent and 2.7 per cent in this period (see table).

While explaining this deviation, the finance ministry says the task of eliminating revenue deficit is more challenging. “The fiscal consolidation during the period 2004-08 was revenue driven, and therefore it created a stress when the revenue buoyancy fell on account of moderation in economic growth,” the ministry’s medium-term fiscal policy statement notes. 

Not surprisingly, the finance ministry is considering a review of the manner in which the government calculates its revenue expenditure. At present, all central allocations for schemes such as Jawaharlal Nehru National Urban Renewal Mission, Pradhan Mantri Gram Sadak Yojana and Rajiv Gandhi Grameen Vidyotikaran Yojana are shown as revenue expenditure even though they create durable assets. Such expenditure is, therefore, more in the nature of capital expenditure, though the assets are not always owned by the central government.

“These revenue expenditures cannot be treated as unproductive in nature. On the contrary, they contribute to growth in economy,” the ministry’s statement observes.  The ministry has, therefore, sought a reclassification of the Union government’s expenditure in a more “pragmatic” way to lay more emphasis on the end outcomes of the expenditure. It is not clear when this exercise will begin, but the definition of revenue expenditure is expected to be reviewed by the finance ministry itself.

At the same time, the ministry’s fiscal policy strategy statement also concedes the limited scope for any significant rise in  revenue receipts going forward and, therefore, recommends greater stress on expenditure compression in addition to a definitional change of revenue expenditure.

The statement points out that the focus now has to be on expenditure reform in order to make the fiscal consolidation process sustainable.  “This is a major challenge, as many of the components of revenue expenditure are rigid in nature and difficult to come down in medium term. At the same time, revenue receipts of the Central government would be lower on account of higher tax devolution to states,” it adds.

In respect of fiscal deficit, the finance ministry’s own roadmap for the coming three years is in tune with the 13th Finance Commission’s recommendations. But the fiscal deficit of 4.8 per cent projected for 2011-12 is higher than the earlier projected deficit of 4 per cent.

In other words, the ministry has already diluted its fiscal deficit reduction plan after taking advantage of the Commission’s recommendation.

The ministry’s plan to reduce its debt to 51.1 per cent of GDP in 2010-11 and to 48.2 per cent by 2012-13 is lower than what the Commission had mandated.