India Debt Crisis vs Euro Crisis

The European debt crisis seems never ending with both Germany and France lowering expectations for a deal to save the Euro at the upcoming European Union summit. The European Central Bank (ECB) has agreed to act as a lender of last resort only on the condition that governments show credible fiscal consolidation. A similar situation might be arising in India.

India's fiscal situation is getting out of hand. The country's fiscal deficit reached almost 71% of its full-year target in the first half of the year. This cast doubts over the government's ability to meet budget goals as federal finances feel the pressure of squeezed revenues and slowing growth. The government is set to fall short of its fiscal deficit target of 4.6% of GDP for 2011-12 by at least 1% and this will take the deficit to 5.6%, higher than the 5.1% deficit seen in 2010-11. The Reserve Bank of India (RBI) has been consistently warning the government about the worsening fiscal situation. But the government has so far ignored the RBI's warning and has failed to implement any kind of reforms with respect to food, fuel, fertiliser and power subsidies. It has also made no progress in improving the tax to GDP ratio. The government subsidy bill in the current fiscal is likely to go up by a massive Rs 1 trillion from Rs 400 bn on account of higher outlays towards fertiliser, food and oil.

But what is more worrying is the worsening fiscal situation of states. The states' fiscal position is also getting into a mess with expected losses of Rs 1 trillion of SEBs (State Electricity Boards) having to be borne by state governments. State level fiscal deficit will exceed 2.2% of GDP projected for 2011-12 if the SEB losses are taken into consideration. As a result India's total debt to GDP ratio is expected to increase from 65% to more than 70% in FY12.

So unless urgent reforms are undertaken by the government, the fiscal situation is not likely to improve any time soon. In fact with economic growth slowing down, revenues to the government might also take a hit, thus adding to the fiscal woes. It is time for the government to end policy paralyses and take some hard decisions. Any slippage on the fiscal gap target has the potential of worsening India's inflationary woes and choking private investment.