Inflation, interest rates not to derail fiscal targets

NEW DELHI: Amidst scorching inflation and monetary tightening, the UPA government appears confident of meeting fiscal deficit targets for this fiscal. At least for now. And at least for the target that doesn���t take into account the borrowings to fund oil, fertiliser and food subsidies.

However, rising prices of crude and ballooning expenditure aided by hardening interest rates could prove tricky. Government borrowing may not be impacted in a major way on account of rising inflation and higher yields, advisors to the government feel.

Although the government believes bond yields will fall in the long term, they are likely to remain high for the time being, with inflation expected to continue at existing levels. Economists feel it will not have a big impact on fiscal deficit immediately, with revenue collections expected to be robust.

���In the longer term, yields will go up, but not very much. Therefore, its impact on government borrowing will not be too much. Only incremental debt issued from now till March 2009 will capture rising yields. For the existing debt, the coupon rates are already fixed.

To that extent the expenditure on account of higher interest payments for the government will, therefore, be limited. In the short term, the impact on fiscal deficit will be minimum. But once yields go up, they will not come down in a hurry next year,��� Saumitra Chaudhuri, member of the Prime Minister���s Economic Advisory Council (EAC) and economic advisor with rating agency Icra said.

���Although tax collections remain on target for this year, tax buoyancy in the long term will come down. Tax rates are nominally fixed, but expenses and interest rates will rise. If macroeconomic fundamentals change, they will not be conducive for economic growth. With increasing prices, economic fundamentals may become unstable. It is, therefore, important to restore macroeconomic balance,��� he said.

Finance ministry sources said only yields in the shorter end will go up. ���One must look at the fundamentals and not the sentiment. Long-term yields will return to normalcy sooner than later. Ideally, there should be repricing of loans in the shorter end and not the ones at the longer end. The yield curve should be flat or inverted, going forward,��� they said.

Although advance tax collections for the first quarter have been robust, officials feel it was on account of last fiscal���s earnings. ���The true picture will emerge second quarter onwards. At this time, it is a little difficult to predict,��� a source said.

Tax collections have been growing at a rapid pace, but the same quantum of growth could not be expected since the base has risen since. The net market borrowing of the Centre for 2008-09 is budgeted at Rs 99,000 crore as against Rs 1,10,727 crore in the previous year.

The optimism on meeting the fiscal deficit target is shared by economists too. Rating agency Crisil���s principal economist D K Joshi said, ���The high yield curves will have a negative impact on fiscal situation for this year. The fiscal scenario doesn���t look as gloomy as it is made out to be. It seems like the slowdown in direct tax collection will be offset by the buoyant ad valorem tax collection. Our calculations show the growth in nominal GDP growth for this year is going to be 16% and this will give a cushion to fiscal situation with an additional inflow of 30,000 crore from this higher growth rate.���

As per budget estimates, gross fiscal deficit at 2.5% of GDP for 2008-09 is down from 3.1% in the revised estimates for 2007-08 and within the FRBM target. The revenue deficit has been pegged at 1.0% of GDP in FY09.