Indian Fiscal – a little slippage is healthy

Let me begin this blog by first thanking all of you for such an overwhelming response to my previous write-up on the Indian Steel Sector. Your comments are truly encouraging (and humbling too) and inspires me to write more.

I have been getting many requests from readers beyond finance domain and also from finance students to simplify the Indian Fiscal Deficit situation and write something without using too many jargons and avoiding large numbers like trillions and billions. However, this is one topic which is full of data and jargons but I am attempting to be as lucid as I can. This will make this a little longer than in a normal scenario. Further, the objective is to make readers think more (rather than imposing my views). Hope you will enjoy the read.

Fiscal Deficit is one number, a control on which is often considered as a holy grail by most of us and any adverse variation, even by a few decimal points, starts unnerving many. For example, the fiscal deficit target for FY18 is 3.2% of GDP. But when on release of monthly data for FY18, one reads that 96% of the fiscal deficit budget is reached in just 7 months, a certain sense of discomfort starts creeping in. I think there is no harm in re-assessing if this target of 3.2% was over ambitious in an environment which requires higher spending by the government.

In the meantime, US Senate has passed a Tax Reforms Bill which talks of reducing corporate tax rates from 35% to 20%. This bill is positioned as a growth oriented reform, though it may add close to USD 1 trillion over the next decade to US’ fiscal deficit. I am mentioning this to highlight how countries worldwide are working on putting in place alternative growth stimulating policies. India is even more compelled to propel growth.

The purpose of this blog is not to do an analysis of month-on-month performance of revenue and expenditure. The idea is to understand where we are on the economic cycle curve and the variables that impact fiscal deficit to enable us to form a longer term perspective which we usually tend to forget in our very frequent monitoring.

While I am not an economist and hence may not be the best person to write an article on such an intense topic, but I have always been intrigued as to why every borrowing is painted with the same brush in all situations. If I have an interesting investment opportunity which can yield an IRR of 18% and I can borrow at 12%, is more borrowing not a wise decision? If my business, with an ROE of 15% has an opportunity to grow at 25% for the foreseeable future and I need to borrow to invest in incremental capacity expansion, should I not leverage? If this holds true for individuals and businesses, why shouldn’t it be true for sovereigns too? As long as the deficits are transitionary, objectives clear, variables productive and intent honest, I think a little push on ‘productive’ variables does no harm in having deficits higher by a few points. The key question in every situation is what is the right amount to borrow? Three important variables that in my mind should influence any borrowing decision are (a) my opportunity loss if I don’t invest now (b) my ability to stagger my investments and delay investments in absence of adequate borrowing and (c) my future capacity to repay debt. I would say, is there a need to borrow, is this the right time to borrow and do I have room to borrow?


There are primarily 6 variables that decides the trend of a fiscal deficit – two being on the income side and four on the expenditure side, they being;

  • Tax revenues
  • Other non-tax sources like dividends, profits, sale of assets, etc.
  • Administrative costs like salaries, wages, pensions
  • Social spending
  • Interest costs and
  • Capital expenditure.

Let me first start with some expenditure analysis of Indian government. As you would observe in table below, out of every Rs 100 spent on revenue expenditure, Rs 83 is pretty much fixed (and unfortunately unproductive too). 55% of this Rs 83 is towards basic administrative costs while an equally large quantum of almost 45% goes in servicing interest. In a way, both are pretty hygiene, maintenance expenditure and has hardly anything to do with growth. With such high fixed cost, there is hardly any room for government to maneuver its finances. However, positive way to look at it is that these being largely fixed in nature, any increase in revenues would have a positive impact on government’s operating leverage thereby having a direct impact on its ability to spend on more productive items like capacity expansion.

Expenditure break-up

    Per 100 Rs tn USD bn


Salaries, Pensions 28 4.01 62.92


Operate / support infrastructure 16 2.19 33.69


Other expenses 3 0.43 6.61


Interest payments 36 5.06 77.85
TOTAL 83 11.69 181.07


Social security 17 2.40 36.92


Capital expenditure 17 2.41 37.08
TOTAL EXPENDITURE 117 16.50 255.07

We now need to get a glimpse of how the income of Indian government is structured and the adequacy (or lack of it) to plan any growth expenditure.

The fact staring on our face is that the net tax collections of Rs 58 is not even adequate to take care of fixed obligations of Rs 83, forget any social security or capital expenditure. If one notices, central government shares more than 50% of its tax revenues with states.

Income break-up

    Per 100* Rs tn USD bn


Tax on Income 60 8.39 129.08
–       Corporates 35 4.93 75.85
–       Individuals 25 3.46 53.23


Tax on expenditure 61 8.64 132.92


Less: income sharing with states (43) (6.08) (93.54)


Less: Grants to states (20) (2.75) (42.31)
Net Tax Income 58 8.20 126.15


Interest, profit, dividends 14 1.98 30.46


Other income 6 0.79 12.18
Total revenues 78 10.97 168.79


Disinvestments 3 0.40 6.15
  TOTAL NET INCOME 81 11.37 174.94

Clearly, there is shortfall to drive other social and capacity creation agenda. If one desires to spend on these items, there is no other alternative but to borrow. Hence the larger question is should investments in capacity creation be a ‘derived’ number by first deciding on the quantum of borrowing or vice versa. I think the need to invest is far more critical than the quantum of borrowing, at least at this point of time (and the following paragraphs would explain that why).


It would be very interesting to understand why I say that there is compelling need to invest. By the way, when I say ‘invest’, what does it mean? It means investing in anything that will create employment. And why do I say so? Maybe following table may give some sense of it.

Population break-up

    Per 100 Actual (mn)


Dependent – children below 20 42 556
Dependent – senior citizens 8 106
Dependent – Unemployed 4 53


Self-employed 23 304
Casual labourers 15 199
Salaried 8 106
TOTAL 100 1,324

Look at the ratio of dependents to independents. The single biggest problem that I notice in the above table is that for every 100 people, 42 are children under 20 years (born on or after 1997). This means that 2 people need employment every year for the next 20 years, till around 2035, totaling to 556 million.

To put it in perspective:

  1. This is almost equivalent to 46 per cent who got cumulatively employed over the last 70+ years. Effectively, what was achieved in last 70 years, now needs to be achieved in only 20 years.
  2. This emerging working class is almost equivalent to the entire population of 579 million of North America (USA plus Canada);
  3. It is only a little less than the population of 739 million of Europe.

Question is, what happens if we don’t give jobs to these children?

Including the 4 existing unemployed, we would have 6 out of 100 people unemployed by 2019, 8 by 2020, 10 by 2021, 12 by 2022, 14 by 2023, 16 by 2024 and so on. Look at the pace at which unemployment will increase. And if enough is not done, what can this lead to? A potential social unrest? Hence, it is not only important to understand the magnitude of this problem but also the seriousness (and potential impact) of the problem on our hand.

Whether one needs to call this a problem or an opportunity is for us to decide.

Hence, if we try to restrict the spending on capacity creation giving priority to fiscal deficit than capacity creation, we are in for some serious social trouble. Hence, while spending whatever little is in hand with the government, it needs to do a fine balancing act for allocating its resources between (a) social security and (b) capital expenditure. A thrust on the former (‘populist) is what previous governments have been focussing on (and that too which entailed severe leakages). However, if we have to create jobs (actually there is nothing like ‘if’, we have to), the spending needs to shift to the later (‘growth oriented’).


There are only two ways in which the government can create job opportunities viz.,

  1. Create an environment where private sector returns back to making investments (‘Private Investing’) and
  2. Increase its own spending on investment – either directly or by pushing Central and State Public Sector Undertakings (‘Public Investing’).

Private Investing seems to have taken a few steps back. Look at what has happened to Gross Fixed Capital Formation (GFCF). It has fallen sharply from 34% in FY12 to around 29% in FY17. Every 4-5% dip in GFCF results in GDP slowdown by about 1%. More importantly this entire slowdown has been by private sector. Public spending has been pretty stable. Two broad reasons for private spending slowdown have been (a) Infrastructure – too many policy uncertainties leading to business inefficiencies, balance sheet stress and almost negligible appetite for incremental capacity expansions and (b) Manufacturing – promoters are finding several interesting distress opportunities and thus while these companies are growing at the company level, it is not leading to any incremental fixed capital formation at the sovereign level.

Government is trying to clear the fog over many policy uncertainties, creating an environment for doing business with ease, selling India consumption story to global MNCs and getting them to set up factories in India, creating single market for selling goods and services, removing stress from financial markets, creating an environment for shifting physical assets in India to financial assets and many more. However, the results on any substantial pick up in GFCF by private sector is not visible.

So what does one do in such a situation? Time is running out, employment creation challenges are like a hanging sword, private spending is not picking up and hence the only solution is for government to provide some basic support by increasing its investment in capacity creations. Government, along with the support of Public Sector Undertakings, has been investing about 7.4% of GDP in capacity creation. Every 1% increase can have about 25 bps impact on GDP growth. But 1% of GDP means about Rs 10 more in our example (Rs 36 shortfall at 3.5% deficit equals to 1028 and 1% of this is Rs 10). So the next key question is when government is already running a 3.2% of fiscal deficit, another Rs 10 spending on capex could move the fiscal deficit a little north of 4%. Can Indian government to afford to do so?


In a normal course, one would have said that such slippages should not be allowed in an economy which has implemented a Fiscal Responsibility and Budget Management Act (FRBM) and targeting a fiscal deficit of 3% by FY19. However, I personally believe that we have lost a very critical time between FY09 and FY14. This was a period of very high fiscal deficits (hovering between 5%-6%), unproductive and leaking social spending and asset sale and throw-away prices. So a large part of the extra borrowing was actually going out of the system. The situation is very different now. Some significant developments have taken place in last 40 months which are likely to have far reaching positive impact on multiple fronts, few of them being.,

  1. Wider tax base – Do you know that even today only 3 out 100 people file income tax return. The number of people actually paying tax is even lower at less than 2. Multiple steps have not only been taken but actually implemented with full force. PAN numbers are linked with Aadhar, Aadhar is now made the pivot for every large expenditure – be it property, jewellery or investment, introduction of GST has added 9.1 million new tax payers. As a country, India was adding just about 6.0 million people every year to the list of those filing income tax returns which is now 1.5x faster than in the past. So the tax base has started widening at a much faster pace and the stated goal of the current government to increase the number of people filing I-T Returns to ~ 100 million by 2020 seems plausible.
  2. Higher tax collections – Let us do a simple math. If India’s GDP is growing at even 6.0% (which is considered much lower than potential), it translates to incremental GDP of Rs 62 and incremental tax collection of Rs 7.50 (current tax to GDP ratio of 12%). Hence the ability to absorb incremental capex of Rs 8-10 per annum can be surely absorbed. And one should remember that this is transitionary. Adequate steps are being taken to get back private investments and revenue increase and efficient spending will only provide more elbow room.
  3. Reduction in wasteful expenditure – While most of my observations are supported by data, this is one area where I don’t have adequate data to substantiate my point. However, anecdotally we have all heard, probably on different occasions, that the subsidy towards 3Fs viz., Fuel, Food and Fertiliser had a lot of leakages. Direct Benefit Transfer (DBT) implementation is in full swing. Government is already claiming a saving of close to USD 10 bn in just 3 years of its implementation for LPG – primarily on account of elimination of ghost claimants through linkage with aadhar and opening of bank accounts. Further, MGNREGA scheme for employment guarantee is seen to be more constructive by actual infrastructure creation in rural areas than ever before.

Considering that there is a compelling need to invest, private investments is slow and foundation is being laid for improving the income side of the fiscal situation, I don’t think it would be appropriate for one to wait for revenues to be visible first. One can easily see the revenues increasing and wasteful expenditure coming down substantially. Hence critical questions are (a) Is incremental borrowing for productive growth or is it for wasteful expenditure and (b) would it translate into income generation / wealth creation? So as long as the spending is productive and growth oriented, I feel that a little relaxation in fiscal slippage is the right thing to do – at least for a couple of years now. Hence, the focus for all of us for next 2-3 years should move away from fiscal deficit to focus on GFCF and manufacturing data. I therefore hope that a little slippage in fiscal deficit would not take the steam out of the positive environment created over the last couple of years.


9 thoughts on “Indian Fiscal – a little slippage is healthy

  1. Every time fiscal deficit has increased, it has led to inflation, even now deficit will increase as a result of tax cuts in GST, at this stage it may not be inflationary given low utilisation and pricing power, but fiscal expansion is not led by infra creation, and if you take into account off balance sheet borrowing from govt entities like NHAI, deficit number may be different.


    1. Thanks Amit. Agree any fiscal expansion could have an impact on inflation as well as rates. What that means is it could lead to corrections in both equity as well as debt capital markets at some point of time. I was looking at GST collection numbers and that’s not too far away from that projected from excise / service tax collections. So that may not add to significant fiscal deficit. However inaction could impact growth and thus ability for fiscal maneuvering. My take is a temporary blip is better than long term structural slow downs.

      But your point well noted and worth a thought.


  2. The past track record of Goverments in general to implement their own commitments leaves a lot to be desired. So while the argument to borrow to invest into productive and job providing opportunities is laudable and indeed needed. We need to be cognisant of the fact that in my view the foreign investor community and rating community will take it with a pinch of salt and there would be attendant implications of fiscal deficit slippages. To expect that we will slip on our path of fiscal consolidation and expect the world to understand and acknowledge the reasons is naive. We therefore need to move ahead with conviction on our chosen path but be prepared to face the consequences of fiscal slippages.


    1. Thanks Sir for your comment. It’s indeed true that neither foreign investors nor rating community are going to take it very positively. While headline does talk of the negatives, my sense is it would indeed have short term implications. We have already witnessed yields widening by 75 bps. Commodities are rising, rates are edgy, growth is still not visible and I personally feel if we overlook the short term pain, the medium to long term implications could be far deeper. Let’s hope that some Driver emerges which translates into higher private investment and more sustainable revenue growth.


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