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Mar 29, 2012, 03.03 PM IST | Source: CNBC-TV18

There is a real fiscal problem, says Ajay Shah

The Finance Minister sees FY13 fiscal deficit at 5.1%. Ajay Shah, senior fellow at NIPFP says, there is a real fiscal problem and things are getting a bit worse. “Things will get worse, if the economy should slowdown,” he warns.

The Finance Minister sees FY13 fiscal deficit at 5.1%. Ajay Shah, senior fellow at NIPFP says, there is a real fiscal problem and things are getting a bit worse. “Things will get worse, if the economy should slowdown,” he warns.

According to Shah, the evidence of a slowdown is greatly overstated. “Contrary to what most people are saying, I don’t think that as yet there is a lot of evidence of an economic slowdown, but there are some leading indicators,” he adds.

Below is an edited transcript of his interview with CNBC-TV18's Latha Venkatesh and Ekta Batra. Also watch the accompanying videos.

Q: The Budget announced an expenditure that was about 55% more than the government’s revenues. The fiscal deficit coming in technically at 5.1%, but there was only an unspecified promise of keeping the subsidies at 2%. There weren’t any tangible ways to get there. What’s your sense? Does the fiscal deficit still leave you terribly disappointed?

A: There is a real fiscal problem and things are getting a bit worse as we go along. Here’s how we should think about it. The net tax revenue to the center, which is really the income of the central government in steady state, leave aside disinvestment, leave aside 3G auctions. These are all one-offs. If you really look in steady state what is the government earning as net tax revenue to the center, it is some 7.59% odd of GDP. Because of the fiscal crisis, year-after-year, the interest-to-GDP has been creeping up. So, this is a quite and slow and insidious and important development.

Interest-to-GDP has gone up from 3% to 3.05-3.1-3.15%. So, when you remove the interest payment and you remove 2.4% for defense, what you really left with is 2% of GDP. So, all of Government of India really needs to squeeze into 2% of GDP, if you want to run on a housewife principle, that is we only spend what we earn. That is a real fiscal crisis, if there ever was one.

In addition to that, there is an exuberant attempt at spending lots of money on welfare programme. The plan expenditure has been raised sharply in the Budget. So, it’s a worrisome situation. Looking forward, we should be very conscious of the dynamic where if the economy should slowdown further then that will adversely affect tax revenues. So, there is unfortunately a tight connection between macro economic conditions and tax revenues.

Things will get worse, if the economy should slowdown. Contrary to what most people are saying, I don’t think that as yet there is a lot of evidence of an economic slowdown, but there are some leading indicators. There are areas of concern. It may well be that the rest of 2012 and 2013 will be significantly worse than where we are today. In that case, it will exert a further negative effect upon tax revenues. So, we are really in a difficult bind on the fiscal situation.

Q: What is your FY13 GDP estimate? Do you think that there is a likelihood that it could be actually worse than FY12?

A: I don’t do GDP forecast from those kinds of horizons. I just want to say that in the recent data, the quarterly GDP data has shown a sharp slowdown. I am a little skeptical about what it is saying because the quarterly GDP data is made using the IIP and the problems of the measurement of IIP are equally present in the quarterly GDP data. So, we should be circumspect about how seriously we take this.

In my humble opinion, the evidence of a slowdown is greatly overstated. There is less of a slowdown than meets the eye.

Q: There is some concrete evidence to say that that IIP number was wrong. We have now Planning Commission sources telling us that they did not include any SME data in the IIP because it was not available, but that data will be available from the ASI for the full year GDP calculations. So, it is going to be divergent. That number should not be relied on. I take your point on that. Now, there is actual evidence of those who did the calculation admitting that the IIP number was wrong. Where does this leave policymakers, for one, the Reserve Bank which will have to say something on April 17th? If you are completely not confident of the fiscal deficit being achieved and you are not that worried about growth as yet then the case is that the Reserve Bank has no case for a rate cut.

A: Yes, I am one of those who are very concerned about inflation. I think that the most important thing the RBI can do in the long-term, for setting the stage for high sustained Indian GDP growth, is to conquer this dragon of inflation which has been unleashed in India ever since 2006-2007.

It is very important to get back to low and stable inflation. Today, when you are an investor in India and you are making plans for five years, you really don’t know what is going to happen to inflation. Today, we do not have confidence in the institutional commitment of the Reserve Bank to actually fight inflation.

RBI keeps saying, ‘we do many things, we will keep changing our mind from day to day. We are not committed to anything.’ Those speeches are doing enormous damage to the anchoring of inflationary expectations.

I feel that the number one priority for RBI must remain to align words and deeds towards the project of conquering inflation. If inflation becomes low and stable, it will assist the investment planning of the private sector. That is the biggest contribution RBI can make towards assisting long-term growth in India.

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