Fiscal Deficits at sub-5.5 per cent vs Higher Borrowing – which one to stick with?

Too many cooks spoil the broth! Rightly said... Post the global financial crisis, many countries – developed and emerging economies went for expansionary monetary and fiscal policies to revive their slowing economy. In India too, the slowdown of economy forced the Central Bank, the RBI and Central Government to announce a series of monetary and fiscal policies which shook the Indian Government’s finances. Three major expenses like provision for Sixth Pay Commission, Loan Waiver and MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Program) and various other subsidies including policy rate cuts led to significant intensification of the India’s Fiscal Deficit.

These unplanned expenditures in terms of loose policies and subsidies have badly affected the fiscal deficits. For Fiscal Year 2010-11, the Central Government fiscal deficit and combined gross fiscal deficit have been pegged at 8.2 per cent. However, there is an apprehension that it can shoot up further. In FY 2009-10, the fiscal deficit was 6.8 per cent of GDP. For FY 2011-12, it has been projected to bring it down to 4.4 per cent.

So, what happens if the fiscal deficit shoots up?

It means that the government will borrow extra to finance their planned and unplanned expenditures. If the government borrows extra for its spending, the level of money supplies rises which may compel to print more money, thus, leading to a hike in inflation rate. 

Current Scenario

With the improvement in economic conditions, the RBI has rolled back many of its accommodative measures introduced in year starting from 2008-09 bringing the policy rates to pre-crisis level. The net borrowing of Rs. 3.81 lakh crore will be executed smoothly except at few occasions where it has been devolved to PDs. However, the 3G and WIMAX auctions which collected worth Rs. 75,000 crore created the liquidity fissures which became a daily headache for RBI. In many occasions, the RBI has reiterated its comfort in repo borrowing up to 1 per cent of Net Demand and Time Liabilities (NDTL). However, the borrowing has been in range of over 2 per cent of NDTL which prompted the RBI to cut the SLR to 24 per cent and also introduced bond repurchase worth Rs. 48,000 crore under OMOs in four tranches.

The tight liquidity scenario was contemplating that the government may go for cancellation of some of its regular weekly borrowing as it has some unspent revenues lying with them. However, the Finance Ministry found support after the Nominal GDP data was released which rose on high inflation and on account of new series in headline inflation as measured by WPI. The nominal GDP
which expanded 19.8 per cent in the first half of the fiscal year 2010-11 provides the room for additional borrowing if the growth rate is intact in the 2^nd fiscal and the budgeted borrowing would amount to 5 per cent of the GDP only. The nominal GDP figures have risen due to burgeoning high
inflation rates which have been in double for most part of years and a new inflation index i.e. 2004-05. 

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Since the fiscal numbers are calculated in current prices and if the government sticks to the number plan, it may have an additional room to borrow. The 5.5 per cent budgeted Fiscal Deficit of the GDP was thought of on account of assumption of 12.5 per cent growth in nominal GDP. However, it has grown at 19.8 per cent in the first half of the FY 2010-11; so the government may announce in reduction of Fiscal Deficit number at sub-5.5 per cent or may go for additional borrowing.

Given the tight liquidity scenario, it is unlikely that they will go for additional borrowing.  However, the quantum of OMOs done totaling Rs. 41,266 crore (in four tranches) may give a reason to borrow again beyond the budgeted specified limit if the liquidity improves in the financial system so as to finance its social schemes. After all, the election preparation is on!

Happy Reading!       - Amar Ranu