Posted in Finance Articles, Total Reads: 1399
, Published on 25 September 2012
Since late 2009, the world has witnessed the slow unfolding of the European sovereign debt crisis. Each act of the play has brought about meetings, intense negotiations, threats of default, debt haircuts, last minute bailouts and a seeming end to the crisis, only to start all over again. Greece has been the focus of the attention as it seemed like the first to fall. The problem has spilled over from the arena of economics to politics with Governments falling and people out on the streets. Like the “Black Death” of yester years, the crisis has spread all across Europe and has raised a question about the survival of the Euro as a single currency.
Why should we in India be worried about events which are taking place far away? Apart from the direct effects of the crisis on our economy, there are several facets of the ongoing crisis which are being replicated in India. The European sovereign crisis has its origins in fact that the member states ran up huge debts (Debt/ GDP ratios of Greece and Italy are 165.3% , 120.1% respectively)under the implicit assumption that they would not be allowed to fail.
The accumulated debt coupled with the fact that the member countries could not monetize the debt (by printing Euros) choked growth driving the economies into a death spiral. With GDP growth plunging into negative figures, the affected economies entered into a vicious spiral of shrinking economy, rising unemployment and total inability to service the debt obligations. A lot of fiscally responsible states were unwilling to bail out the errant members by simply creating a combined Euro bond or empowering the European Central Bank (ECB) to be the lender of last resort.
How Indian states are similar to and different from Euro currency member states?
In terms of similarity, the Indian states can be thought as being members of a Rupee area. They cannot print the Rupee and monetize their debts. In terms of difference; India is a single political and economic union. The states do not have any control over the currency. The economic powers are heavily tilted in favour of the Central Government.
Revenue Receipts of Centre( in Rs. Crore)
Revenue receipts of States(Excluding Grants from Centre in Rs. Crore)
Table 1: Revenue Receipts of Central and State Governments from 2002-2011.
As seen from Table 1, the revenue receipts of the central government nearly equal or are more than the combined revenue receipts of all the state governments put together. In terms of economy, we can consider the Centre as the largest state affecting the public finance of this country.
Global Financial Crisis and Beyond
As seen from Chart 1, the combined fiscal deficit was on the fall due to the constant rise in annual GDP growth rate. However, the onset of the global financial crisis in 2008 forced the Central Government to announce a stimulus package for the economy. This involved a cut in many indirect taxes.
Chart 1: Combined Fiscal Deficit and GDP growth rate (2002-2010)
The Indian economy which had already been integrated with the European and US markets began to feel the pinch. Once the economy started slowing down, the profligacy began to pinch.Matters have become exacerbated due to a sharp deceleration of the Indian Economy.
The problems have been compounded by a ballooning fiscal deficit driven by rising subsidies and an equally worrisome current account deficit. Another worrying aspect of the increase in fiscal deficit is that a vast majority of the amount is used in funding revenue expenditure and capital expenditure is falling. This is tantamount to sacrificing future growth to fund immediate needs. The Government failure to curb in market distorting subsidies has meant that several commodities are being sold below market level prices.
Such under pricing has made sure that there is no decrease in domestic demand despite international acquisition prices reaching high levels. Such huge levels of Government debt is starving the private sector from funds and fuelling inflationary tendencies.
The uncontrolled fiscal deficit has in turned also fueled a current account deficit as displayed in Chart 2.
Chart 3 displays the worrying high proportion of expenditure pertaining to the revenue side.
Chart 2: Relationship between the twin deficits.(Source: RBI)
Chart 3: Revenue Expenditure as percentage of total Central Government expenditure (Source: RBI)
The current global macroeconomic scenario is fraught with multiple risks. The Government cannot keep on monetizing the debt infinitely. We have reached a situation where all the economic firepower has been exhausted and we have little means left to deal with external shocks. Unless the Central Government takes fiscally prudent steps, however unpopular they may be, the country is headed for a period of economic turmoil. Like Greece, the economic woes would then spill over into the political arena.
The bright spots are that a majority of the debt owed by the Central Government is internal in nature and rupee denominated.
Should the Government delay and dither on fiscal consolidation, the day is not far when the scenes witnessed in Athens might be replicated in places close by.