Project clearances critical, especially for CAD
The finance ministry’s decision to cancel the last tranche of Rs 12,000 crore of market borrowings—due this Friday—sends out a powerful signal as to how determined the government is to stick to its revised 5.3% fiscal deficit target. Though the actual announcement came as a surprise, the ministry’s attempts to curb expenditure have been visible—in December, the government actually had a positive saving of R8,230 crore—for many months now. Indeed, one of the reasons for the extremely tight liquidity situation is the refusal of the government to spend money. But while the fiscal deficit looks comfortable, at least for the current year, the current account deficit (CAD) looks quite worrying. Indeed, that’s why credit rating agency Moody’s put out a warning Monday, calling it a “credit negative increase in a trend of higher trade and current account deficits”. What’s common to the twin deficits, however, is the importance of the government coming up with the right mix of policies in the year ahead to stimulate growth and to clear investment bottlenecks.
In the case of the fiscal deficit, for instance—tax-to-GDP fell from 11.9% of GDP in FY08 to a likely 10.3% this fiscal—increase in growth rates will help raise revenues. A slowing of corporate profits, for instance, has translated into lower tax-to-GDP ratios for corporate taxes; ditto for the slowing of top line growth and its impact on excise and other collections. And thanks to poor policy that has resulted in large petroleum under-recoveries, corporate tax collections have taken another big hit. Assuming the oil PSUs end up bearing a subsidy burden of even R90,000 crore in a year, that’s a lower corporate tax of around 0.2-0.3% of GDP.
The more immediate problem—since this year’s fiscal deficit looks broadly on course—is that of the CAD which, as Moody’s pointed out Monday, rose from an average of less than 1% of GDP in the first half of the 2000s to a peak of 5.3% of GDP in the quarter ending September 2012. And, thanks to a slowing in FDI inflows and a jump in the CAD, FDI which financed over 100% of GDP in FY08, today finances just a fourth of the CAD, with the rest being financed by volatile flows. While short-term debt has risen from 16.2% of total debt in FY07 to 22.5% in FY12, the share of volatile capital flows to reserves has risen, RBI’s Financial Stability Report points out, from 67.3% at the end of March 2011 to 81.3% at the end of June 2012. What’s more interesting is what’s behind the rising CAD. Much has already been written about the role of gold—oil imports are, erroneously, taken as a given even though large subsidies have driven up consumption—but few have taken into account the role of coal imports. Coal imports used to average about 0.5 % of GDP in the pre-Lehman period. But thanks to a ramp up in power production that has been matched by Coal India’s inability to produce enough coal, coal imports have averaged 0.9% of GDP over the past two years—as a consequence, one fifth of the deterioration of the CAD is because of coal over the last two years. Clearing coal blocks fast is an obvious policy imperative, but the more important one is to allow private sector players in. Next week’s budget will be an important signal to where the twin deficits are headed, but the real stuff depends on policy actions through the year.