A K Bhattacharya: Get the diagnosis right

It is unfair on the part of the govt to just blame a slowing economy for its tax revenue shortfall

Now that the advance estimates of national income for 2011-12 are out and greater clarity has emerged on the nature and extent of the current economic slowdown, it is important to demolish the myth that a section within the finance ministry is trying to propagate in its bid to explain away the dismal state of government finances. The myth is that the marked slippage in fiscal deficit this year is largely because of the economic slowdown in the current year that had not been correctly anticipated at the time of finalising the 2011-12 Budget numbers.

The fiscal deficit target of 4.6 per cent of gross domestic product or GDP is now all set to widen to at least 5.5 per cent. At the time of presenting the 2011-12 Budget last February, the government had projected a real GDP growth rate of nine per cent. The advance estimates for growth this year, released yesterday, placed it at 6.9 per cent. The difference is substantial particularly because there were no nasty surprises during the year to upset the calculations — and, therefore, it is a comment on how unrealistic the government’s policy makers were.

Now, it is true that lower economic growth does have an adverse impact on revenues, particularly tax collections which have a direct correlation with the pace of economic activity. However, lower economic growth should take only a tiny part of the blame for the substantial fiscal deficit slippage taking place in the current year. A deeper malaise, and one that has a far more debilitating impact on the long-term health of the economy and government finances, is the manner in which the finance ministry has managed its expenditure in spite of falling revenues and the growing realisation that key revenue projections were inflated and without much basis.

This becomes quite apparent with the latest data now available on government’s total revenues and expenditure in the first nine months of the current financial year. A quick perusal of them will tell you an amazingly naive way of handling government finances. Take, for instance, the government’s total receipts (minus borrowings) in April-December 2011, which fell 16 per cent over the figures for the corresponding period of 2010. The Budget at the start of the year had projected a total receipts (minus borrowings) growth of around four per cent.

It is not that the bad news of actual revenues falling behind the target had hit the government all of a sudden. Indications of revenues slowing down were there almost from the start of the year. The remarkable feature of this dismal revenues scenario is that except a 7.5 per cent growth in tax revenues (that too would perhaps become negative without the impact of inflation), all other key revenue parameters showed a decline.

Non-tax revenues fell by 60 per cent. Now it is easy to attribute this fall to the absence of one-off revenue streams like the one from telecom spectrum auction proceeds which boosted such receipts in 2010-11. But that is not the full story. The Budget makers knew of this when they prepared their numbers and, therefore, projected a 43 per cent drop in non-tax revenue for the year. So, why would non-tax revenues fall by almost a third more than what was budgeted? Clearly, nobody was minding that crucial part of the government’s non-tax revenue business.

Non-debt capital receipts too fell by 46 per cent, thanks to the government's inability to offload its stake in public sector undertakings, admittedly in view of a tepid stock market. The 73 per cent increase projected under this head was clearly a reflection of irrational exuberance. Instead, the government may end the year with a sharp drop in non-debt capital receipts, even after assuming that some amends could be made in the last three months of the year. Even its tax revenue calculations went seriously wrong. Should the growth in tax revenue collections have fallen to just 7.5 per cent, compared to an 18 per cent Budget target set at the start of the year?

Yet, the government’s action on the expenditure front was conspicuous by its absence. Its non-Plan expenditure in the first nine months of the current financial year increased by over 15 per cent, while the Budget had projected a marginal decline of such expenditure by about a per cent. There was some restraint on Plan expenditure. Against a target of allowing only 12 per cent growth, the government’s Plan expenditure in April-December 2011 showed a rise of 11 per cent. But thanks to the non-Plan expenditure excess, total expenditure in the first nine months of the year grew by 14 per cent, while the Budget target allowed an increase of only 3.4 per cent.

So, it would be unfair on the part of the government to just blame a slowing economy for its tax revenue shortfall and attribute that to the widening of its fiscal deficit. The reality is that the government failed to keep a check on its expenditure, after anticipating a slower economic growth rate. What this has meant for the government is not only a sharp widening of its fiscal deficit, but its primary deficit outlook too has got bleaker. The government’s primary deficit, a measure of its current year’s performance without the burden of interest payments caused by actions of previous Budgets, is set to rise way above the projected level of 1.6 per cent of GDP. That does not bode well for the government.