Understanding the nuances of India’s Fiscal policy- By Dilshad Billimoria

July 2015

Fiscal Policy, as implemented by our government, revolves around managing the income and expenditure of the nation to achieve specific goals such as infrastructure development, economic growth, increased capital formation, and overall economic activity enhancement.

The government's income is derived from various sources, including taxes (both direct and indirect), dividends, interest receipts, disinvestment, and spectrum sales. On the other hand, government expenditure falls into planned and unplanned categories and includes items like subsidies, capital spending on infrastructure, and interest on borrowed debt.

When a country's expenses surpass its income, it results in a fiscal deficit. Fiscal policy can also influence a nation's trade balance and its position in the Balance of Payments.

As of 2015, the major portion of government receipts is contributed by direct and indirect tax collections. Individual and corporate taxes together make up around 8 lakh crore, accounting for 55% of total receipts, while approximately 6.50 lakh crore is generated from indirect tax collections, constituting around 45% of receipts. In total, tax collections amount to about 14.5 lakh crore, while the GDP stands at 130 lakh crore. This means that our tax-to-GDP collection ratio is merely 10%, despite having a substantial number of taxpayers in the 30% tax bracket. This situation highlights the challenges in tax collection in our country.

Indirect tax collections include excise duty, custom duty, and service tax, with service tax being the largest contributor. Meanwhile, the government's capital receipts primarily come from disinvestments and make up only 6.50% of total government receipts. A significant 93% of government receipts come from revenue receipts, of which tax collections contribute a substantial 80%.

Government expenditure is divided into planned and non-planned categories, with non-planned expenditure being the more substantial portion at 74%. Capital expenditure, which drives growth, development, and infrastructure, accounts for only 12% of the total expenditure.

Non-planned revenue expenditure, which includes interest, subsidies, defense, and pension grants, incurs the highest costs. According to the 2014-15 budget estimates, the total expenditure, including both planned and non-planned, amounts to Rs 17,77,477 crore, while total receipts are at 14,49,490 crore. Consequently, India faces a fiscal deficit of Rs 3,27,987 crore, which is equivalent to 4.1% of GDP. The largest components of expenditure are interest on borrowing, at approximately 4.5 lakh crore, followed by subsidies, which total 2.5 lakh crore. These subsidies are allocated for items such as oil, food, and fertilizers.

Due to the fiscal deficit, the government borrows from the public, which can lead to inflationary pressure and higher interest rates. In an ideal scenario, the government should allocate its spending to projects that foster economic activity and growth. However, budgetary reforms often prioritize populism to win votes, which does not significantly contribute to economic growth. Taxpayers tend to seek tax cuts and reductions, which can adversely affect the income and expenditure accounts, resulting in a greater fiscal deficit. By increasing revenue receipts by 1-2%, we can make a significant impact on reducing or eliminating the fiscal deficit.

Approximately 82% of our fiscal deficit is financed through internal borrowing via debt market securities, known as Government Securities or G Secs. The remaining 18% is funded through external debt, Treasury Bills, and small savings.

To reduce our fiscal deficit, the government should consider measures such as reducing subsidies, expanding the tax collection net and base, increasing capital expenditure to stimulate overall economic growth, enhancing tax compliance, and striving for an increase in nominal GDP. Printing currency is not a recommended option, as it can lead to inflation.

In summary, managing fiscal policy is a complex task, but addressing the fiscal deficit is crucial for economic stability and growth.

Dilshad Billimoria Director and Certified Financial Planner Dilzer Consultants Pvt Ltd. SEBI Registered Investment Advisor July 22, 2015