Aggregate demand* accelerated further in 2010-11. Private consumption and investment were the key drivers of growth in 2010-11, even though investment moderated somewhat in Q3. Government consumption expenditure has decelerated and this rebalancing should be maintained by focusing on fiscal consolidation. In this context, it is important to contain subsidies that are at risk of overshooting the budgetary provisions as global oil prices rise.

Demand conditions remain supportive of growth

II.1 Aggregate expenditure, in real terms, accelerated in 2010-11 with private consumption as well as investment expenditure growing at a brisk pace (Table II.1). Going forward, private expenditure is likely to continue to be the main driver of growth, though some moderation can be expected in response to high inflation and demand-side policy measures. Government consumption expenditure has decelerated significantly in 2010-11 and this rebalancing could be maintained this year by staying on the path of fiscal consolidation. Investment expenditure is expected to remain moderate. Recovery in investment expenditure from the soft patch in Q3 of 2010-11 would depend on pick-up in execution of large infrastructure projects.

Saving rate driven up by public sector, investment rate by private corporates

II.2 Both saving and investment rates improved in 2009-10. Improvement in the overall saving rate has been led by the public sector while the investment rate has been boosted mainly by private corporate sector (Table II.2).

Key fiscal indicators budgeted to improve in 2011-12

II.3 The key fiscal indicators of the Central Government showed an improvement in 2010- 11 (RE) attributable mainly to larger than expected proceeds from telecom spectrum auctions. The Government chose to utilise these excess receipts to increase allocations for rural infrastructure, implementation of Right to Education Act, plan assistance to States and recapitalisation of public sector banks. The Budget intends to carry forward the process of fiscal consolidation in 2011-12 through reduction in expenditure growth. Recognising that the windfall benefit of one-off non-tax revenues of 2010-11 would not be available during 2011-12, the revenue deficit as a ratio to GDP is budgeted to remain unchanged. Nonetheless, the gross fiscal deficit (GFD) as ratio to GDP is budgeted to decline reflecting compression in capital expenditure in 2011-12 (Table II.3).

Fiscal consolidation process to continue but quality and pace matter

II.4 Over the medium term, the Government has envisaged a gradual reduction in key deficit indicators in consonance with its macroeconomic projections and conservative stance on revenue collections. However, key deficit indicators are likely to remain higher than the prescribed path of the Thirteenth Finance Commission and accordingly, the Government would not be able to achieve revenue balance by 2013-14. Although the Government focuses on reducing ‘effective revenue deficit’, which excludes capital grants to States, the headline revenue deficit, as a ratio to GFD, is expected to remain higher in 2011-12. This indicates that a larger portion of GFD would emanate from revenue deficit, reducing the availability of resources to undertake capital outlays.

Tax buoyancy helps though tax cut rollback was partial

II.5 The Central Government is calibrating the roll-back of taxes/duties towards the pre-crisis levels recognising the emerging inflationary situation. The growth in gross tax revenues, however, is budgeted to be lower for 2011-12 as compared with 2010-11 (Table II.4). By keeping the standard rates for excise duty and service tax unchanged, the Government intends to stay on course towards introduction of goods and services tax. With the implementation of direct tax code in 2012-13, the tax buoyancy is expected to improve and raise the gross tax- GDP ratio gradually to 11.3 per cent by 2013-14, though lower than its pre-crisis peak of 11.9 per cent in 2007-08.

Focus on quality of expenditure important in fiscal consolidation

II.6 Sharp moderation in revenue expenditure growth and marginal decline in budgeted capital expenditure are expected to contain expenditure growth this year. The fiscal consolidation strategy for 2011-12 is primarily expenditure driven, reflecting the impact of lower growth in expenditure on salary and pensions and subsidies. While controlling non-plan revenue expenditure growth is a positive feature, the compression in capital expenditure poses concerns regarding the quality of fiscal consolidation.

Capping of expenditure on subsidies is subject to upside risks

II.7 The Budget’s lower projection of subsidies for 2011-12 is subject to the underlying assumption of no major variation in international fertiliser and petroleum prices during the entire span of 2011-12, which may not hold (Table II.5). There is an upside risk in the case of fertiliser subsidy as fertiliser input prices have increased. Fertiliser subsidies are likely to exceed budgetary provisions unless urea price is decontrolled or Nutrient-Based Fertiliser Subsidy scheme succeeds in effectively capping the total fertiliser subsidies. Further, the rising international oil prices may generate pressures on the fiscal situation in case there is a delay in the corresponding adjustment in domestic prices, leading to larger subsidy expenditure towards under-recoveries of downstream oil public sector units. Furthermore, the introduction of National Food Security Bill may also have additional expenditure implications.

Robust sales growth points to enduring demand conditions

II.8 Corporate sales growth remained robust during Q3 of 2010-11 and together with inventory movements signalled continued buoyancy in demand. However, profit margin came under pressure, on account of higher input and interest costs (Table II.6). All components of input costs viz., expenses on raw materials, power & fuel and staff costs witnessed significant increase. Reflecting the tightening of monetary policy rates, interest payments have increased. Companies accumulated stocks as reflected in the rise in stock-in-trade to sales ratio. This may at the current juncture of cycle indicate that producers anticipate a pick-up in demand (Chart II.1). Early results for Q4 from a small sample of companies suggest that sales accelerated during the quarter.

Investment intentions of corporates moderate further in Q3 of 2010-11

II.9 Investment intentions of corporates witnessed a further slowdown in Q3 of 2010- 11 after beginning to moderate from the previous quarter. Out of total costs of projects sanctioned in financial year 2010-11 (April- December), the largest share is envisaged to be invested in the power sector followed by the telecommunication sector and metal and metal products.

Demand conditions may soften a little, helping to rebalance growth

II.10 The pick-up in private spending in 2010- 11 helped in sustaining growth recovery from the slowdown seen in the immediate aftermath of the global financial crisis. This was essential as the recovery in the initial phases was driven by fiscal stimulus that resulted in large government spending. Nevertheless, the pickup in private consumption and fiscal consolidation has enabled rebalancing of demand. Restraint on subsidies in the wake of high global oil prices, and maintenance of investment demand are critical for sustaining private demand.

^*Despite well-known limitations, expenditure side GDP data are being used as proxies for components of Aggregate Demand.