Podcast 20th February 2015
Hi I am Arjun Parthasarathy speaking.
This Podcast topic is on “Union Budget 2015-16 can do wonders if FM delivers on Fiscal Consolidation”
The FM, Arun Jaitley will present the Union Budget for fiscal 2015-16 to the Parliament on the 28th of February 2015. The Union Budget is seen as an event by the market, which speculates on budget numbers and policies that could either be positive or negative for the markets in the short term.
Taking out the market noise, the budget influences one key constant, which affects the economy and the markets, the most. The key constant is the fiscal deficit, which is simply the difference between the total revenue and total expenditure of the central government.
Fiscal deficit is a constant as the government consistently spends more than it earns. The deficit may vary in absolute and relative terms (as percentage of GDP), but it is a deficit all the same. Given that the government funds close to 90% of its deficit through issuance of government bonds (market borrowings), the deficit impacts government bond yields, which in turn impacts interest rates in the economy. Interest rates affect both income on savings for households and cost of borrowing for households and corporates.
The government has been profligate over the last seven years. Fiscal deficit in absolute terms has gone up by 300% since 2007-08 and this has led to government’s stock of outstanding bonds rising by 250% over the period. The sharp rise in stock of outstanding bonds has led to interest costs rising for the government and interest costs now form 24% of total government expenditure. Interest costs will only rise every year as the government adds to its debt given its fiscal deficit.
The government has to do two things to bring down interest cost on its debt. The first is to keep down inflation expectations, which in turn will lower its borrowing cost. The second is to allocate more resources for creation of capital assets, which in turn will improve output in the economy, increase supply and also create primary, secondary and tertiary demand. However for the government to spend more on value creating assets, it has to raise revenues and reallocate scarce resources from non productive expenditure such as subsidies to productive expenditure
The government has the ability to both bring down inflation expectations and spend more on value creating assets by following the fiscal consolidation path of containing fiscal deficit to 3% of GDP in 2016-17 from current levels of 4.1% of GDP. Focus on improving the tax to GDP ratio from current 10.6% levels, lowering the subsidy bill from over 2% of GDP and spending on creation of assets will help the government on its fiscal consolidation path.
Thank you for listening in.