Budget Analysis I: Understanding Deficits

In a series of write-ups starting today, I would try to unravel the mystery behind the 'Union Budget', the fiscal document of Indian Government. At the outset, let us try to understand the nature of deficits: Budget Deficit is a common economic phenomenon, that occurs when the spending of a government exceeds its financial savings. Deficit differs from debt, which is an accumulation of yearly deficits. Famous economist John Maynard Keynes believed that deficits help countries climb out of economic recession. The first budget under the new UPA regime is a 'borrow and spend budget' attempted to spur economic growth.

To counter the global slowdown, the govt. provided three fiscal stimulus packages during the last fiscal (FY 2008-09), which has lead to the fiscal deficit for FY 2008-09 ballooning to 6.2% of our GDP. The level of govt. spending budgeted for FY 2009-10 is Rs.10.2 trillion, up 36% from 2008-09, directed largely towards funding social sector programmes. This will result in a huge spike in Govt. borrowings or fiscal deficit which is projected at 6.8% of GDP in FY 2009-10, a level never seen since 1991. The higher borrowings will lead to interest payments climbing up to 20% of total govt. spending. The FM has taken a big gamble, and he may be playing with fire, unless economic growth is perked up soon. Although the FM has categorically sated that fiscal deficit will be reigned in below 4% within the next 2 fiscals, it will be a test of govt.'s fiscal prudence.

The Govt. will have to tread carefully, as the higher Govt. borrowing may crowd out private investment, leading to a pressure on inflation and push the interest rates higher which will be a roadblock for faster economic growth. It may also result in lowering India's sovereign rating by international rating agencies. The budget aims at restoring higher consumer spending and corporate investments. In his budget speech FM has outlined 3 major challenges for the economy:

• To lead the economy back to the GDP growth rate of 9% pa at the earliest
• Deepen and broaden the agenda for inclusive development
• To re-energise the government and improve delivery mechanisms

The FM has sacrificed short term gains/measures for the sake of long term growth. It is a consumption lead, growth oriented budget and we wish the FM success in his endeavours.