With 76% of the year?s fiscal deficit limit already reached in the first half of the year, the finance minister has no option but to introduce savage cuts in various types of expenditure including, most likely, in some of the UPA flagship schemes such as the MGNREGA?this is what prompted rural development minister Jairam Ramesh to describe the planned cuts as savage in a letter to the Prime Minister. Certainly, in terms of their impact on GDP growth, the immediate impact will be what Ramesh describes it. With little private sector activity, much of the momentum in the economy has come from the government over the past many quarters. In Q1FY14, for instance, government expenditure as a share of GDP (at current prices) rose to 12.7% as compared to an average of 11.8% for FY13 and 11.5% in FY12. This frontloading of government expenditure?this trend will be even more visible in Q2 data which will be put out later this month?is largely what pushed up growth. In Q1FY14, had it not been for the 9.4% hike in ?community, social & personal services?, largely an euphemism for government expenditure?this has been the highest growth in the last 9 quarters?even the 4.4% overall GDP growth achieved would not have been possible. And to some extent, the slowing of government expenditure is already visible?the September fiscal deficit, for instance, was just R8,000 crore more than that in August while it grew by around R70,000 crore in each of the past few months. The composition of this reduction is also interesting?revenue expenditure grew by 21% in Q1FY14 but by just 12% in Q2, capital expenditure grew by 36% in Q1 but by under 7% in Q2. The slowing will be even more dramatic in later quarters.
While it is true that cutting back on such schemes will hurt GDP growth, it has to be kept in mind that, given the leakage levels in them, cutting back on them is not necessarily a bad thing. Average loss/leakage levels in the PDS, for instance, are reckoned at 45-50% and the much-touted MGNREGA is adding to the number of jobs in the country by just 1-2% a year. What is important, however, while cutting government expenditure is to ensure the private sector is set free at the same time?if this doesn?t happen then, while the impetus from government spending comes down, there will be nothing to take up the slack. This is precisely what happened in the 1990s when, in the rush for privatisation, government investment in power collapsed but private investments never took off as several important reforms required for private investments simply never happened. The government is making some attempts to unshackle private investments in both the oil and telecom sectors for instance?the Empowered Group of Ministers will be meeting to take a telecom decision later this week?but unless more of this is done, the likely cutbacks in government expenditure will have a greater impact than that imagined. In the run-up to the elections, that can?t be a great thing.
