With the Union Budget just around the corner, Finance Minister, Arun Jaitley is in a dilemma when it comes to the fiscal consolidation.
Tax revenues have fallen short of expectations and investment inflows have not been as robust as expected. Also, expenditure cuts have not been successful followed by a sluggish growth.
This has placed Arun Jaitley at a crossroad where he can increase public expenditure and push the promise to bring India's fiscal deficit to 3.5 percent of GDP in FY16 or he can concentrate on meeting his deficit targets and delay measures to boost growth.
Experts are divided on how the Finance Minister should proceed. Reserve Bank governor Raghuram Rajan, for instance, maintains that fiscal consolidation should be the government's priority.
“The Indian economy is currently being viewed at the beacon of stability because of the steady disinflation, modest current account deficit and commitment to fiscal rectitude,” Raghuram Rajan said in a press conference.
“This needs to be maintained so that the foundations of stable and sustainable growth are strengthened,” he added.
Rajan expects the increased burden on the exchequer from factors like the 7th pay commission and one-rank-one-pension (OROP) scheme to put upward pressure on inflation.
Keeping this mind, RBI has held off repo rate cuts till clarity comes from the government but the government machinery insists these requirements have been considered into the current fiscal deficit targets.
“OROP and 7th Pay Commission will be fully factored into the government’s deficit target for FY17,” said Jayant Sinha, minister of state for finance, in an interview to CNBC-TV18 on Thursday.
“OROP was a promise we had made and have fully delivered on. We have worked towards providing a fair and balanced package,” he added.
Not just government officials, this question has divided the banking community as well.
“As long as we don't go excessive on fiscal spending, and we can maintain it at 3.9, it will be preferable to spend and keep the economy going and then we can consolidate next year,” Aditya Puri, MD and CEO of HDFC Bank told CNBC-TV18.
“If fiscal latitude is taken, to put in for investment, and we don't go from 3.9 to 3.5 percent, if we stick to 3.9percent, that's what's happening the world over, the earth will not shatter, and it’s probably the right thing to do in my opinion,” he added.
Content with the current growth rate, Uday Kotak, MD and CEO of Kotak Bank said that 7 percent is a good number in today's world.
“Now whether it is 7, 7.5 or 8 percent, as long as we build a stable growth rate that is sustainable. We want to make sure that the fiscal deficit is in control, otherwise that will put pressure on bond market and bond yields will go up. (we are) Already seeing yields under pressure - upwards, partly coming out of conversion of discom debt on state balance sheets; therefore we must look at deficit consolidation between the centre and the states,” he said.
Missing the fiscal deficit target may not hurt India’s credibility or lead to an immediate change in the country’s sovereign rating. This may be the only source of relief for Arun Jaitley.
As rating agency Moody's says, “India already has a weak fiscal position, and a slight missing of the target has been worked into the country's ratings, which is just a notch above junk status.”