100 days of New Government: Economy turning Around but Significant Fiscal Risks Ahead
Chief Policy Advisor, EY India.
With the first quarter growth at 5.7% in FY 15, which is a full 1% point higher than the corresponding FY14 first quarter growth, the economy does show signs of turning around. The overall investment sentiments have improved although gross capital formation as percentage of GDP at current market prices, that is, the investment rate, in the first quarter of FY15, at 31% is actually lower than that of the previous year at 32%. It is not additional investment but improved demand and possibly some administrative push ensuring faster clearances of projects that has led to better utilization of capacities in sectors like mining, manufacturing, electricity, gas, and water supply and construction. Some of the increase in demand came in April and May due to the elections.
There are however significant economic and fiscal risks ahead. First, with the deficient and uneven spread of Monsoon, agricultural growth is bound to slowdown. Second, with the coal and power sectors facing critical uncertainties, it may be difficult to build upon the momentum in mining and manufacturing. Third, the news on the fiscal front is not so promising. By July 2015, that is four months into the year, more than 60 percent of the full year’s fiscal deficit and more than 70% of the full year’s revenue deficit have already been incurred. This is similar to what happened last year. But last year, in order to achieve the deficit targets, there was a significant contraction of government demand. As a result, growth in the social, community and public sector declined sharply in the second, third, and fourth quarters. The first quarter growth in this sector in FY 15 is also more than 9%, almost similar to that in the previous year. If this is allowed to fall by contracting government demand, the effect on other sectors and the overall growth will be adverse.
Prospects of tax revenue growth in line with budget estimates do not seem bright. Growth in centre’s gross tax revenues in the first four months was only 5.5% over tax revenues in the corresponding period in the previous year. The budget estimates assume a growth of centre’s gross tax revenues over the full year at 18%. Revenues from Customs and Union excise duties show negative growth. The nominal growth of GDP at market prices in the first quarter was 11.6% while the budget has assumed a nominal growth of 13.4%. With inflation trending downwards and real growth likely to be limited to a range of 5.5 to 6% in the remaining quarters, the nominal growth for the year as a whole may turn out to be about 2% points lower than the assumption in the budget. Given the performance in the first four months, neither the assumption of tax buoyancy at more than 1.3 nor the nominal growth assumption of 13.4% made in the Union budget are likely to be met. Any shortfall in revenue performance will also subdue resources flowing to the states further curtailing prospective push to demand.
Thus, while prospects of the economy are brightening, there are significant fiscal risks ahead. A sustainable recovery needs to be based on more solid foundations. This should include actual implementation of GST and comprehensive reforms of direct taxes and subsidies.
Views expressed are personal.