Government's spending plans may choke private investments: analysts

The proposed spending plans of the central government on populist schemes even as its fiscal deficit is ruling at a decade-high of over 6 per cent of the country's gross domestic product, is likely to squeeze private sector investment plans in the coming years.

Going by the tone of the president's address to the Parliament and the subsequent directive of the prime minister to his cabinet colleagues, it seems the government may give a go-by to fiscal prudence this year as well.

Prime minister Manmohan Singh has asked the finance ministry to ensure that the next union budget adequately and appropriately reflects the priorities and programmes outlined in the president's address.

The president's address also does no detail measures to boost finances of the central government despite some loose talk of plans to mop up funds through PSU divestment.

President Pratibha Patil's speech on Thursday did mention that the government is losing control on the fiscal side, but it did not say how the government intends to rein in fiscal deficit, which, according to the Reserve Bank's reckoning, is putting pressure on interest rates and threatening to choke private investment.

Massive government borrowing last fiscal had rattled the bond market, pushing up the yield curve of long-term bonds to its steepest in a decade.

The interim budget in February had proposed limiting centre's fiscal deficit at 5.5 per cent of GDP but had ended the year with an over 6.0 per cent deficit, due mainly to a dent in tax receipts during the downturn and tax concessions to certain hard-hit sectors of the economy.

Government's borrowings are expected to top Rs400,000 crore ($85 billion) in the current fiscal (2009-10). That could prompt investors, mainly banks, to seek higher returns for buying government bonds.

The high bond rates in turn could push up the interest rate levels and discourage private investors from raising funds in the market or borrowing from banks.

The RBI has almost halved the repo rate, at which it lends to banks, by 4.25 percentage points to 4.75 per cent since October in a bid to boost growth. Government's borrowing plans have now pushed the yield spread between 1-year bills and 10-year government bonds to 260 basis points. The yield on 10-year bond has risen 127 basis points this year alone.

While a revival of economic growth would help revenue growth, high spending need not as a rule generate enough revenue to bridge the deficit and is risky to that extent, say analysts.

The union budget for 2009-10, to be presented in Parliament on 3 July, may include detailsm of the government's borrowing plans, including its  borrowing needs and the actual deficit.

Some analysts say the government hopes the high spending to help generate enough growth to increase tax revenues and so relieve pressure on the budget deficit. But that may be risky.

While borrowing to support spending has been part of Manmohanomics since his days as finance minister in the Narasimha Rao government, the current spending spree amidst falling revenue receipts is sure to affect long-term growth of the economy.

The Rs70,000 crore debt waiver for small farmers in 2008-09 and tax concession for exporters, combined with an expanded jobs programme and higher support prices for foodgrain procurement could put pressure on the UPA government's borrowing programme.

Analysts say, there is a clear need for more stimulus to lift growth, but they also see little fiscal space left for the government to do that. Any further monetary easing by the central bank may not prod commercial banks to lower lending rates, instead expansionary fiscal policy would only hinder RBI's efforts to lower lending rates and ease credit flows to productive sectors of the economy.