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India’s deficit test: Doable, after all

Subhendu Sarkar | LightRocket | Getty Images

India faces a tough feat of achieving its fiscal deficit target this year, but major banks have voiced their confidence in the government.

Asia's third-biggest economy recorded an $83 billion fiscal deficit, or 99 percent of its full-year target, during the first eight months of financial year 2014-2015 that began in April, data showed last week.

This would mark the worst performance since financial year 2008-2009 when India embarked on a path of stimulating its economy during the financial crisis. It also raises concerns that the government would miss its target to reduce fiscal deficit to 4.1 percent of gross domestic product (GDP) by March 2015, down from 4.5 percent in the previous year.

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But a deeper dive into the figures revealed that rather than runaway expenditure that generally leads to the over-shooting of fiscal deficit, it's the dramatic slowdown in revenue collection that's taken a toll.

"We understand that the target is ambitious mainly due to lower tax revenue on account of the gradual recovery in economic activity and the slowdown in nominal growth with deceleration in inflation," Morgan Stanley stated in a note on Tuesday.

Tax collections were up 6.5 percent on a cumulative basis in the first seven months of the financial year, much lower than budgeted growth of 17.7 percent, according to data from Citi. Meanwhile, nominal growth is widely expected to miss government forecasts of 13.5 percent.

With tax revenue expected to improve in the coming months and no unfettered rise in expenditure, Morgan Stanley is confident India's fiscal targets will be met.

"Tax collection picks up seasonally toward the end of the fiscal year, with direct tax collection between December and March at 51.4 percent of total (five-year average)," the bank said.

Even if the fiscal picture continues to worsen, analysts say the government has available tools at its disposal to defend the budget targets.

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Societe Generale economist Kunal Kumar Kundu says current Finance Minister Arun Jaitley, like his predecessor P. Chidambaram, would likely resort to non-conventional measures like postponing subsidies or forcing public sector companies to pay more dividends in order to "stick to the stiff target."

Other possible strategies include leaning on state-owned financial institutions to bail out the government, or even curtailment of state expenditure.

"Clearly none of these are desirable measures, but then desperate times call for desperate measures," Kundu added.

Citi concedes that while news on the fiscal front is "not so good" as tax collections remain "in the slow lane," it expects the government to enact expenditure cuts to rein in the deficit.

"While the drop in crude prices will help contain the subsidy bill, similar to last year, a sharp cut in plan expenditure in the current fiscal to the tune of 600 billion - 800 billion rupees ($9.3 billion - $12.6 billion) will be necessary for the government to meet its 4.1 percent fiscal target," the bank said in a note this week.