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India may be aiming for smaller deficit

A year after the FM announced he was pressing "the fiscal pause button", analysts say he is likely to hit "play" again next week.

india Updated: Feb 23, 2006 16:12 IST

A year after the finance minister announced he was pressing "the fiscal pause button" to put deficit reduction plans on hold, analysts say he is likely to hit "play" again in next week's annual budget.

But when Palaniappan Chidambaram stands up in parliament on Tuesday he will have a tough job balancing the need for fiscal discipline with political and industry pressure to spend more on education, health and infrastructure.

Chidambaram is widely expected to meet his 2005/06 federal fiscal deficit target of 4.3 per cent of gross domestic product, wider than a year earlier 4.1 per cent.

Now that the $700-billion economy is growing at 8 per cent, helped by industry and services which make up 75 per cent of GDP, analysts say buoyant tax revenues present Chidambaram with a great opportunity to relieve stress on government finances.

For the year starting April 1, many see him aiming for a budget deficit of 4.0 per cent of GDP, in line with a law obliging him to trim the ratio, though he is again likely to rely on growth in the economy -- and thus the tax take -- instead of spending cuts to achieve it.

"It remains to be seen how Chidambaram balances the compulsions of higher spending on various social schemes," said Siddharth Mathur, analyst at JP Morgan.

"The bottom line is that cutting the fiscal deficit next year is not impossible, but it is not going to be easy in the current political setting."

The federal budget deficit had fallen for three years running before 2005/06, aided by growth that has averaged 6.5 per cent since 2001/02.

But that is only part of the story. Taken with the budget shortfalls of all the states, India's overall deficit is about 7.7 per cent of GDP, among the highest in the world.

Interest payments on its public debt, estimated at 101 per cent of GDP, eat up 43 per cent of total revenue and are one of the biggest impediments to achieving the double-digit growth sought by New Delhi policy makers to alleviate poverty.

Floating its way off the deficit

The Congress party-led coalition, supported from the outside by India's communist parties, has relied on higher tax collection from a broader base and rapid economic growth to fund ambitious spending plans of nearly $6 billion unveiled last year. Not all of that was spent, but is likely to come through in 2006/07.

It will be tough to cut spending when 13.5 per cent of revenue goes on politically sensitive subsidies such as fuel and farm fertilisers. But the government will eventually have to implement expenditure reforms if it wants a structural reduction in the deficit, Morgan Stanley analysts say.

"We believe the improvement in tax-to-GDP is largely cyclical," analysts Chetan Ahya and Mihir Sheth wrote in a recent note. "Although implementing major reforms will be politically difficult, the government should at least ensure that the expenditure trend does not deteriorate."

Last year, the government announced a rural job guarantee scheme expected to cost $2.4 billion in 2005/06.

On the revenue side, it failed to raise significant funds via sales of stakes in state-run firms as plans foundered on opposition from the communists, and analysts say that source of finance is unlikely to yield much next year either.

One pressing area for large-scale spending is infrastructure. India's roads, ports, rail and power networks are overloaded and in need of an estimated $150-$200 billion in the next decade if the country wants to maintain rapid growth and spread some of its wealth among 260 million poor.

Some analysts expect a modest increase in spending on infrastructure, health and education in the budget. But others say with the economy booming, now is the time for India to get its house in order.

"Ideally, the government should invest more in infrastructure," said Madan Sabnavis, economist with NCDEX, a commodity exchange in Mumbai.

"But the pressure on public finances is so huge, improving that should be given top priority. Development spending can wait at a time when industry is doing well."

First Published: Feb 23, 2006 16:12 IST