Primary deficit: Silver lining in govt's efforts to contain fiscal deficit

The parameter, which excludes interest payments on govt borrowings, has declined to 0.2% of GDP in the revised estimate, from 0.3% in budget estimate; govt aims to eliminate it in 2020-21 and 2021-22

The union government is projected to slip on the fiscal deficit target for two years in a row – 2018-19 and 2019-20 – according to the interim Budget presented by finance minister Piyush Goyal. 

However, it has improved on another key parameter of fiscal consolidation. And that is primary deficit, which is basically the excess of government expenditure (not including interest payments), over its receipts.  Essentially, this is fiscal deficit, excluding interest paid on government borrowings.

According to interim Budget documents, the Centre's primary deficit is now projected to decline to 0.2 per cent of GDP in the revised estimate (RE), from 0.3 per cent given in the budget estimate (BE) for 2018-19. For the next financial year, it is projected to stay at 0.2 per cent in BE. In 2017-18, primary deficit stood at 0.4 per cent.

For the first time, a road map for primary deficit was given in the medium-term fiscal policy-cum- fiscal policy strategy statement, which is presented along with the budget documents under the Fiscal Responsibility and Management (FRBM) Act.

According to this document, the government aims to eliminate primary deficit in 2020-21 and 2021-22.

If one looks at fiscal deficit as a whole, a major portion is due to interest payments made by the government on its borrowings. For instance,  fiscal deficit is projected to be Rs 7.04 trillion in 2019-20. Of this, Rs 6.65 trillion is interest payments. The remaining Rs 39,000 crore is estimated to be the primary deficit.

The primary deficit is a key aspect of fiscal consolidation for debt sustainability.

In his dissent note to the N K Singh committee report on the fiscal responsibility and budget management (FRBM), former chief economic advisor Arvind Subramanian had advocated relying on primary deficit for the purpose of debt sustainability.

“I would propose a simpler architecture, comprising just one objective: placing debt firmly on a  declining trajectory. To achieve this, the operation rule would aim at a steady but gradual improvement in the general government primary balance until the deficit is entirely eliminated,” he had said.

The FRBM panel had relied on the targets for fiscal deficit and revenue deficit, with a provision of anescape route of 0.5 percentage points in a year that faces eventualities.

It had said that the Centre should ensure that the debt of general government (Centre and the states) does not exceed 60 per cent of GDP by 2022-23, with the union government debt at 40 per cent of GDP by that year.

In fact, the interim Budget projected the Centre’s debt to come down to 47.3 per cent of GDP in 2019-20 from an estimated 48.9 per cent in the current financial year. It is further projected to come down to 45.4 per cent in 2020-21 and 43.4 per cent in 2021-22.

It is primarily for this debt reduction, that Subramanian had called for focusing on primary deficit.

In fact, towards the fag end of the previous United Progressive Alliance government, then Planning Commission deputy chairman Montek Singh Ahluwalia had advocated relying on primary deficit. He had said the primary deficit is the internationally accepted measure of fiscal consolidation because interest rates can vary for reasons other than government belt tightening.

In their book, Federalism and Fiscal Transfers in India, C Rangarajan, former chairman of the Prime Minister's Economic Advisory Council, and D K Srivastava, then director of the Madras School of Economics, have recommended that 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, argued the authors.

Devendra Pant, chief economist at India Ratings, said the primary deficit should be targeted from debt sustainability point of view. Primary surplus would mean that debt to GDP would fall, he said.

To buttress his point, he said between 2003 to 2008, GDP growth rate was high and primary deficit was low or marginally surplus in a couple of years, which resulted in debt to GDP ratio to fall.

However, not everyone was convinced. Madan Sabnavis, chief economist at CARE Ratings, said,” I think that primary deficit is  misleading.”

In fact, other members of  the FRBM panel – chairman N K Singh, former finance secretary Sumit Bose, then RBI governor Urjit Patel and economist Rathin Roy- had also rejected the idea of Subramanian on the primary deficit. They said running primary surpluses is necessary but not the sufficient condition for debt to GDP ratio to decline.

Even if the country generates very high primary surpluses, if its stock of debt is large, it will not be enough to offset the interest payments and debt path can be explosive, they said.