Indian economy: Not just a twin but a triple-deficit problem looms

While the twin deficit problem of widening fiscal and current account deficits has been spoken about, a third problem of widening deficit in the states also stares the Indian economy in the face

The Indian economy is staring down the barrel of a twin-deficit problem, if not a triple-deficit one. The Department of Economic Affairs' latest monthly report on the economy has highlighted the possibility of a significant worsening of the fiscal deficit and the current account deficit.

According to the report, government revenues will decline following cuts in excise duties on diesel and petrol. So the gross fiscal deficit will go up. “Increase in the fiscal deficit may cause the current account deficit to widen, compounding the effect of costlier imports, and weaken the value of the rupee, thereby further aggravating external imbalances, creating the risk (admittedly low, at this time) of a cycle of wider deficits and a weaker currency.”

But while it is correct that revenue from fuel taxes will be lower than budgeted, the fact is that GST revenue is also likely to be far higher than what was budgeted. The government had budgeted Rs 3.35 trillion from excise duties in 2022-23. Following the cut in excise duties on fuel in May 2022, it said that the revenue impact would be about Rs 1 trillion over the year. That is about 30 per cent lower than the initially budgeted amount.

Also Read: Where is India's economy headed after FinMin's twin deficit warning?

The government had also budgeted Rs 6.6 trillion from Central GST for 2022-23. However, if the first two months of this financial year are anything to go by, actual GST collections will likely be about 25-30 per cent higher than budgeted. If nothing else, inflation will ensure collections far outstrip the budget estimates.

That said, it is unlikely that higher GST collections will be able to balance the higher food and fertiliser subsidies announced this fiscal. Higher subsidy outgo and the government’s determination not to let capital expenditure drop mean we will see the fiscal deficit widen.

This determination can be seen in the fact that it met 98.5 per cent of its annual capex target for 2021-22. In April 2022, it had already achieved 10.5 per cent of the year’s capex target. There is, thus, not much that can be done about the fiscal deficit.

It is also almost certain that the current account deficit will widen further. India’s merchandise trade deficit more than doubled to $45 billion in April-May 2022. Accounting for services, the deficit was lower, at $27 billion, but that too is five times what it was during the same period of last year.

Driven by high oil prices, India’s import bill will likely continue ballooning. There’s not much that can be done about that, either.

Interestingly, there is a looming third deficit that is likely to be as much of a burden, if not more: the deficits of the states. Even before the pandemic, the ratio of the states’ revenue to their GSDPs had been falling. The only thing keeping them afloat was the GST compensation paid by the Centre.

The period for that compensation ends this month. From July onwards, the Centre does not have to compensate the states. This is likely to have a pretty severe impact on their deficits.

The government can, however, help narrow this deficit without any cost. During the upcoming GST Council meeting on June 28-29, the states will clamour for the extension of the compensation period. Fiscally speaking, this would not impose any cost on the Centre because the compensation is paid using the collection from a cess.

If it does happen, such an extension should come with a definite promise from states that they will find ways to increase their tax revenue. The compensation can’t be indefinite.