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February 25, 2013: Many in India believe that reduction in subsidies (to bring down fiscal deficit) will further raise the already high prices of day-to-day household consumption items such as food, fuel or electricity, and be detrimental to the interest of the common people. Is it really so? Is the relation between reduction in subsidy and increase in the prices of essentials so straight? Is high fiscal deficit (caused by burgeoning subsidy burden) contributing to the problem of inflation in India? On the eve of the upcoming Union Budget, it would be pertinent to examine the implications of high fiscal deficit for the (growth of) productive capacity of the economy. Subsidy accounts for roughly 2.5 per cent of Indias GDP. If one adds bonds issued to oil marketing companies (in lieu of subsidies) to compensate for under-recoveries, it will be another 2 per cent of Indias GDP. Thus, subsidy covert and overt is blocking roughly $90-100 billion annually and is a major cause of high levels of fiscal deficit. Indias fiscal deficit (Centre and States taken together) of 8-9 per cent of the GDP is high by any standard. It far exceeds all other BRIC nations China (1 per cent), Brazil (2.9 per cent) or Russia (1 per cent). The combined fiscal deficit of the States stands at 2.5 per cent of Indias GDP, which is well below the limits set by the Thirteenth Finance Commission. Clearly, the Centre seems to be more responsible for Indias fiscal mess.
Revenue deficit
Fiscal deficit in itself is not a problem, but if one looks at the constituents of Indias fiscal deficit, one finds that revenue deficit accounted for 76 per cent of gross fiscal deficit in 2011-12. Only 24 per cent of deficit went for the creation of additional productive capacity i.e. will add to the future supply of goods and services. Besides, 24 per cent of the resources must generate enough returns to service 100 per cent of the additional public borrowings (i.e. fiscal deficit), which is not feasible. The result would be more borrowings or imposition of additional taxes in future to service past debts. That will reduce domestic (household) savings, and ultimately investment, as domestic savings is the pre-dominant source of investment in India. High fiscal deficit also crowds out private investment by raising the cost of capital for private sector. On the other hand, the Government, with access to cheap finance (through SLR mechanism that mandates investment of 23 per cent of bank deposits in government securities), uses the funds to fill its revenue gap, which does not lead to any increase in supply of goods and services. This would lead to more inflation in future with negative consequences for the economy. Sustained inflation induces switchover from financial assets to physical assets such as gold and real-estate as a hedge against low or negative returns on savings. Inflation makes the exports of a country expensive, leading to trade deficit and depreciation of its currency. That, in turn, increases the rupee cost of imported items (e.g. crude), adds to subsidy burden and, in turn, fiscal deficit in a controlled price environment.
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agri infrastructure as well as intensifying R&D for better yield in non-cereal segment. It also calls for improving postharvest infrastructure. Hopefully, FDI in retail will fill this gap.
Electricity
The major cause of the increase in electricity prices is increasing coal price. Since domestic production of coal is constrained (despite India possessing huge reserves of coal) by regulatory impediments, electricity producers have to rely on expensive imported coal that increases their cost. Alternative sources of electricity, in particular hydro, wind and solar, together, account for less than one-third of the countrys electricity generation.
www.thehindubusinessline.com/opinion/columns/fiscal-deficit-devil-lies-in-the-detail/article4452563.ece?css=print
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