The 2016-17 Union Budget has possibly been the most difficult since 1991. Given the absence of any consensus understanding about the state of economy, there were very divergent expectations from the budget.
Chief Economic Adviser Arvind Subramanian pushed for an expansionary budget leading to higher fiscal deficit. RBI governor Raghuram Rajan pushed for exactly the opposite course of action so as to provide fiscal stability.
Both choices had their upside as well as downside and none of the choices can be considered unthinking. Finance minister Arun Jaitley went with controlling fiscal deficit. Thus in a world of burgeoning fiscal deficit and negative interest rate, India emerged as a hub of economic sanity. However, difficult times as they are this choice also has its consequences.
Upward bias in GDP
As the table 1.1 shows there is a possible upward bias in measuring nominal GDP.
The absolute nominal value of every single nominal GDP estimates has been revised downward from their initial estimates. Post the revision, the nominal GDP growth shows a sequential downward trajectory from 2012-13 onwards and is likely to continue to at least 2015-16.
To the extent the fiscal deficit is measured as a proportion of nominal GDP, downward revision of nominal GDP causes the deficit percentage terms to slip even if the government had met the absolute rupee value of the deficit.
When Jaitley presented the 2015-16 budget on 28 February 2015, he projected a fiscal deficit of Rs 5.55 lakh crore. This was expected to be 3.9 percent of the FY16 nominal GDP estimated then at Rs 141 lakh crore, which was 11.5 percent higher than 2014-15 nominal GDP of Rs 126.5 lakh crore estimated then.
However Rs 126.5 lakh crore got revised downward to Rs 124.9 lakh crore, and expectation of 11.5 percent growth was slashed to a decade low 8.6 percent.
In order to meet the 2015-16 fiscal deficit target of 3.9 percent (of nominal GDP) the absolute fiscal deficit was revised down to Rs 5.35 lakh crore. Until 30 September 2015, the fiscal deficit stood at Rs 3.78 lakh crore, which is 70% of the revised absolute 2015-16 fiscal deficit target.
The government spending in the second half of 2015-16 is expected to be squeezed significantly in order to meet the defict target as was also the case in the previous year.
In 2014-15, as of 30 September 2014 the government had already exhausted 86 percent of its projected full year deficit. In order to keep a check on fiscal deficit target, the government significantly curtailed the spending. This was among the key factors which may have dragged down the nominal GDP growth to 7 percent level in the second half of 2014-15. The first half nominal GDP growth was above 13 percent. Full year 2014-15 nominal GDP growth was 10.8%.
A repeat in H2 2015-16?
However, the government expects a full-year nominal GDP growth of 8.6 percent in 2015-16. Since the nominal GDP in the first half grew 7.2%, to hit a full-year nominal GDP growth of 8.6%, the second half nominal GDP must grow in excess of 9 percent. Given the expected squeeze in government spending in the second half 2015-16, the nominal GDP growth of during the period may suffer.
The Budget 2016-17 assumes a growth of 11% during the next fiscal. Given the absence of any significant triggers as of now, it is difficult to envisage what may potentially prop up an approximately 8 percent nominal GDP growth of 2015-16 to 11 percent in 2016-17.
Some support may come from the rural spending the budget has focussed on. If the rain gods favour India this year, then together they may set the stage for a recovery.
Support on the currency front may possibly come from the finance minister's bid to create the reputation for fiscal stability. However, will this be enough to more than negate the squeeze in nominal GDP growth given the curtailed government spending? The answer to this question is possibly not.