Ah, the fiscal deficit has declined. Should we cheer?

Fiscal deficit for this fiscal has come down from 5.5% as per budget estimates to a revised estimate of 4.8%.

But no one’s brought out the bubbly yet. Typically, the markets cheer a lower fiscal deficit number. Not this time.

Bond yields continue to trade close to their highest levels for this fiscal.

What gives?
For one, the drop of 70 basis points comes on the back of an anticipated 20.3% growth in nominal gross domestic product (GDP) rather than a reduction in government borrowings due to higher revenues and lower expenditure.

The nominal GDP for 2010-11 is estimated at Rs7,877,947 crore, up from original estimates of Rs6,934,700 crore.

The estimated fiscal deficit at Rs381,408 crore was 5.5% of nominal GDP, which was expected to grow 12.5%. This has now come down to 4.8% on revised nominal GDP growth of 20.3%.
Then again, the spurt in nominal GDP growth is due to inflation.

Inflation as measured by the GDP deflator implicit in the nominal GDP estimates for 2010-11 stands at 9.6%.

The government may pat its back on lowering the fiscal deficit and other related numbers including public debt-to-GDP ratios, but it is only doing so by creating inflation and not by prudent revenue-expenditure management. In economic parlance, it is called inflating away the fisc.

This has worrying implications.

The first is that the stock of debt does not go down, it only goes up. The outstanding liabilities of the Centre as of 2010-11, at Rs3,306,626 crore, is double that of 2004-05 wherein the outstanding liabilities were Rs1,603,785 crore. The rising debt, coupled with rising inflation, has raised the average cost of the debt from 7.2% levels in 2004-05 to 7.9% levels in 2010-11.

Interest payments, as a result, are over 25% of revenue expenditure.

The Fiscal Responsibility and Budget Management (FRBM) Act sought to address the problem of rising stock of debt, but it was thrown away during the crisis period of 2007-08. The government has to show seriousness in the FRBM Act for the market to cheer a lower fiscal deficit number.

The subsidy policy is another reason for the markets not cheering a lower fiscal deficit number.

The only bright spot in the subsidy policy is that the government does not try to hide the deficit by issuing oil and fertiliser bonds. The subsidy bill will be paid out in cash.

The government raised fuel prices marginally due to a sharp rise in oil prices (25% year on year) but has not really made any effort to rationalise subsidies. The bill is shooting up and is higher by almost Rs100,000 crore from budget estimates.

The government will have to spell out a clear subsidy policy in the budget for the markets to cheer.