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India fiscal gap narrowing but read the fine print

But analysts say these figures don’t provide the complete picture and some expected pressures, including pre-election spending, suggest underlying stresses on the overall budget position.

Finance Minister Palaniappan Chidambaram delivers his annual budget on Feb. 29, the last full one of this administration.

Analysts expect him to say he bettered a goal of cutting the federal deficit to 3.3 percent of GDP for the year to March 31 from 3.7 percent a year earlier.

“He will be able to beat the 3.3 percent target and post a lower ratio this year,” Shubhada Rao, chief economist with Yes Bank, said.

“He is seeing a high growth in tax revenues, which will help him contain the fiscal deficit close to around 3 percent.”

But this year’s target, enshrined in a four-year-old fiscal responsibility drive, excludes the deficits of state governments. If they were included, the overall shortfall would be more like 6.0 percent of GDP, economists estimate.

It also ignores off-balance sheet items, such as oil bonds issued in lieu of raising government-set fuel prices to match global trends. With world oil prices rallying strongly and hitting records just this week, the government may have to issue more bonds in coming quarters.

And although the government must by law meet a fiscal deficit target of 3.0 percent in the financial year starting on April 1, national elections due by May 2009 and an upcoming pay review for 3.4 million government employees will add to the fiscal challenges.

India has been on a drive to improve its public finances as large deficits are costly to fund, and servicing debt diverts money which could be spent on development.

Economic growth averaged 8.8 percent over the four fiscal years ending 2006/07, and 8.7 percent growth is expected for 2007/08.

That has played the largest role in bringing down the federal deficit, as the government has done little to tackle wasteful spending since it came to power in May 2004, analysts said.

Citigroup economist Rohini Malkani said in a recent report that while headline expenditure numbers were in line with estimates, they masked items such as oil bonds and fertiliser subsidies.

“If included, they would result in the deficit rising by 70 basis points to 4 percent of GDP,” Malkani said.

Tax blessing

Finance ministry data show corporate tax receipts rose 39 percent between April and mid-February this year over the same year-earlier period and income tax receipts rose 46 percent.

“Especially in the last quarter, taxes are likely to be extremely buoyant,” said Abheek Barua, chief economist at HDFC Bank.

From nearly 10 percent of GDP in the late 1990s, one of the highest levels in the world, analysts reckon India’s combined federal and states’ deficit is about 6.0 percent -- above its 5.5 percent target but below 6.4 percent in 2006/07.

But a government-appointed panel is expected to recommend a 30 percent jump in wages to federal workers across the country when it submits its report in April.

A similar panel in 1997 raised civil servants’ salaries at an annual cost of $13 billion. State governments were forced to match the pay rise to their workers, leading the overall fiscal deficit to blow out to 8.5 percent of GDP in 1998/99 from a year earlier 7.1 percent.

Yes Bank’s Rao said the latest pay round would put pressure on the federal and particularly the state governments in 2008/09.

“It just prompts the state governments to look at additional avenues to raising resources in addition to the recourse to market borrowings,” she said.

Vote-bank allure

Elections will also prove a temptation. Analysts expect more issuance of oil bonds to help state-run oil firms cope with high feedstock prices, despite a recent hike in retail fuel prices, and more subsidies on fertilisers and food to protect India’s millions of poor from rising prices.

The legal requirement to shrink the deficit to 3.0 percent in 2008/09, and cut the revenue deficit, the difference between revenue and recurring expenditure, to zero from 1.5 percent is likely to act as a brake on serious profligacy.

But analysts say the pay review means eradicating the revenue deficit will be difficult and elections mean higher expenditure is likely, even if buoyant tax collection can absorb most of the rise on the balance sheet at least.

“The last four election years have always produced budgets which have had expenditure levels higher than average expenditure growth,” said Samiran Chakraborty, chief economist with ICICI Bank.

“It is quite likely to be a higher amount of expenditure in this budget as well,” Chakraborty said.