This document discusses India's twin deficits of fiscal deficit and current account deficit. It notes that India has struggled with double-deficit issues for a long period. The fiscal deficit arises from government expenditure exceeding revenue, while the current account deficit is caused by a gap between exports and imports. The document analyzes the components of government expenditure and imports, and how they have contributed to the deficits. It also examines the linkages between economic growth cycles, the components of GDP, and the trajectory of the deficits. The slowing exports and rebounding imports during economic downturns are seen as widening the current account deficit.

1. Twin Deficit Analysis- Growth perspective
Rahul Chokshi
022-61598021
Hasan Razvi
022-61598049
8th January 2013

2. Key Pointers
 Deficit- Nature & Issues
 Government Expenditure- Role & Nature
 Revenue Spending- Plan & Non-planp g p
 Capital Expenditure- Plan & Non-plan
 Merchandise trade- Overhang on Current account
 Invisibles Trade Balance- Services dominate
 Role of Government Spending in Economic Growth
 Linkage between GDP and Deficit
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 Fiscal Path Committed v/s Expected
 Dealing with the Deficit
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 Risks to Deficit trajectory
 Annexure
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3. Deficit- Nature & Issues
Twin Deficit Trajectoryj y
5
6
7
1
2
3
4
%
Source: RBI and Altius research
0
1
FY08 FY09 FY10 FY11 FY12
Fiscal Deficit as a % of GDP CAD as a % of GDP
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 India has for a long period now been plagued with double-deficit problem, viz., the Current Account Deficit
(CAD) caused by a wedge between exports and imports and the Fiscal Deficit (FD) arising due to
expenditure surpassing the revenue in a given period.
 Deficit is deemed acceptable in an economy that is developing rapidly stoking consumption and investment
Source: RBI and Altius research
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 Deficit is deemed acceptable in an economy that is developing rapidly stoking consumption and investment
demand owing to which mismatches arise in meeting the growth momentum. Nature of deficit on the fiscal
as well as current accounts dictates the sustainability of the growth trajectory.
 For instance, higher fiscal funding on account of recurring revenue expenses leaves out lower room for
3
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capital spending to grow, similarly higher imports for consumption demand instead of manufacturing inputs
eventually weakens the domestic currency substantially.

4.  The figure alongside attempts to segregate the
Government Expenditure- Role & Nature
Share of Capital-Revenue Expenses
100% The figure alongside attempts to segregate the
overall expenditure into revenue and capital
spending based on their share in the aggregate
expenditure.
60%
70%
80%
90%
100%
 The figure thus portrays the share of capital
expenditure at around 11% of the total expenditure
and revenue spending at nearly 89% over the last 5
fiscal years. 10%
20%
30%
40%
50%
 Similarly, the second figure has divided the total
imports broadly into consumption and investment
goods.
100%
Share of Consumption-Investment Imports
0%
FY08 FY09 FY10 FY11 FY12 FY13H1
Capital Expenditure Revenue Expenditure
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 Thus consumption related imports occupy a greater
portion in India’s import basket, at nearly 66%.
Whereas, capital and export related goods that
signify manufacturing demand stands barely at
50%
60%
70%
80%
90%
100%
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around 33%.
 The period under consideration is mainly from FY08
to the current fiscal year (according to availability of
data) primarily due to the various growth cycles, 0%
10%
20%
30%
40%
50%
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) p y g y ,
viz., boom, slowdown and revival that were
observed in the short span under consideration.
Source: Bloomberg, RBI and Altius research
0%
FY08 FY09 FY10 FY11 FY12 FY13Q1
Consumption goods Investment goods

5. Fiscal deficit

6. Revenue Spending- Plan & Non-plan
Y-o-Y growth of Total Revenue spending
40
25
30
35
40
5
10
15
20
%
Source: India Budget and Altius Research
0
FY07 FY08 FY09 FY10 FY11 FY12 FY13
Budgeted Actual Estimated
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 The continued divergence of actual revenue spending from budgeted target has been the prime factor to push up
overall expenditure. The above figure also substantiates the proposition that slowing growth translates in a
higher revenue spending by the government.
Source: India Budget and Altius Research
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 The plunge in real GDP growth to 6.72% in FY09 from 9.32% growth seen in FY08 translated into a higher public
spending by the government as the revenue spending rose to INR 7.94 tn from a budgeted target of INR 6.58 tn
and a 34% growth from FY08’s revenue spending of INR 5.89 tn.
 On the other hand immediately in the next fiscal year 2009-2010 as the economy showed signs of recovery
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 On the other hand, immediately in the next fiscal year 2009 2010 as the economy showed signs of recovery
posting a real growth rate of 8.39%, the actual revenue spending also posted a minimal slippage at INR 9.06 tn
from a budgeted target of INR 8.97 tn.

7. Capital Expenditure- Plan & Non-plan
Total Capital spending as a % of GDP4
2
%
0
 The central issue with capital expenses is that it has actually been below the budgeted level for a substantial
b f h l d d hi d h f i l i f h
Source: 12th & 13th Finance Commission Report, India Budget and Altius Research
FY07 FY08 FY09 FY10 FY11 FY12 FY13
12th & 13th Finance Commission Extimates Budgeted Actual Estimated
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number of times in the last decade. This undershoot of capital expenses is a matter of concern as the
same highlights the inability to achieve a targeted level of infrastructure that proves to be a
roadblock in paving the path to economic growth recovery.
 The slowdown seen in FY09 owing to the global credit crunch forced the government to support domestic demand
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by heavy revenue expenses as the trade-off by reducing the capital spending; easing from 2.4% of GDP in FY08
to almost 1.6% of GDP in the given year. The targeted 31% Y-o-Y growth of capital expenditure in FY13 is also
set to fall short of the budgeted target given the Y-o-Y growth pattern of merely 17% in Apr-Nov period
 Ironically capital spending that is non recurring and developmental in nature fails to meet its budgeted target as
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 Ironically capital spending, that is non-recurring and developmental in nature fails to meet its budgeted target as
the cost of an overshoot in revenue is borne by the haircut in capital spending. This induces a sort of cyclical
characteristic to the deficit making it structural rather than a temporary one.

8. Current Account Deficit

9. Merchandise trade- Overhang on Current account
 The slowdown in an economy, where on one hand impacts manufacturing activity stunting investment demand, it
failed to meaningfully dent the domestic consumption demand.
 Thus a drop in manufacturing and investment demand eventually impacts the exports. For instance, credit crunch
of 2008 that resulted in a contraction in export demand from the developed world, thus India’s exports growth
l d t 15 3% FY09 f th t ti t 0 6% i FY10 ( i l h ) f th fi t ti i th l t d dslowed to 15.3% FY09 further contracting to 0.6% in FY10 (revival phase) ,for the first time in the last decade.
 The slowdown in investment demand also impacts the import of bulk import goods and capital goods highlighting
the slowdown in investments and manufacturing activity, however, the issue remains the pace of slowdown, as
merchandise imports exhibit a quicker rebound compared with exports. The contraction in imports lasted to merely
3-quarters whereas, exports witnessed a longer spell of contraction. (Annexure figure 3)
Trade deficit & CAD as % of GDP (INR cr) Foreign Trade trajectory (USD mn)
0
0 5
0
FY07 FY08 FY09 FY10 FY11 FY12 FY13H1
45
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‐10
‐5
2 5
‐2
‐1.5
‐1
‐0.5
FY07 FY08 FY09 FY10 FY11 FY12 FY13H1
%
%
25
35
%
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‐20
‐15
‐4.5
‐4
‐3.5
‐3
‐2.5
%
%
5
15
%
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Source: RBI and Altius research
‐25‐5
4.5
CAD Trade deficit
‐5
FY08 FY09 FY10 FY11 FY12
Export Y‐o‐Y Import Y‐o‐Y

10. Invisibles Trade Balance- Services dominate
 The services trade balance plays an dominant role in influencing the invisible trade portion of the current account,
as the pulse of services balance is imitated by the invisibles balance. The economy has relished a surplus on the
invisibles balance aided by robust services growth, although the external shocks does impact its growth trajectory.
 With the most recent slowdown being triggered by the credit crunch and recession seen in the developed world, the
services exports growth also exhibited a contraction in corresponding quartersservices exports growth also exhibited a contraction in corresponding quarters.
 As the ‘financial crisis’ deepened, the Y-o-Y exports fizzled out to merely 4% growth in Q3 of FY09 compared with
25% growth seen in the same quarter in FY08. This was followed with 4-consecutive quarters of contraction in
exports.
 A similar impact was also seen on the import front, although there is an almost spontaneous rebound in services
import growth.
Exports- Invisibles: Services (USD mn) Imports- Invisibles : Services (USD mn)
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Prolonged export contraction Spontaneous rebound in imports
30
40
50
60
70
80
30
40
50
60
70
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20
‐10
0
10
20
30
Y08Q1
Y08Q2
Y08Q3
Y08Q4
Y09Q1
Y09Q2
Y09Q3
Y09Q4
Y10Q1
Y10Q2
Y10Q3
Y10Q4
Y11Q1
Y11Q2
Y11Q3
Y11Q4
Y12Q1
Y12Q2
Y12Q3
Y12Q4
Y13Q1
Y13Q2
%
20
‐10
0
10
20
Y08Q1
Y08Q2
Y08Q3
Y08Q4
Y09Q1
Y09Q2
Y09Q3
Y09Q4
Y10Q1
Y10Q2
Y10Q3
Y10Q4
Y11Q1
Y11Q2
Y11Q3
Y11Q4
Y12Q1
Y12Q2
Y12Q3
Y12Q4
Y13Q1
Y13Q2
%
10
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Source: RBI and Altius research
‐30
‐20
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
Invisibles Import growth Y‐o‐Y Services Import growth Y‐o‐Y
‐30
‐20
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
Invisibles Export growth Y‐o‐Y Services Export growth Y‐o‐Y

11. Growth Implications of Twin Deficit

12. Role of Government Spending in Economic Growth
 The table given below attempts to substantiate the impact of slowing growth on changing composition of GDP The table given below attempts to substantiate the impact of slowing growth on changing composition of GDP
contributed by government, consumption and investment expenditure over the past economic cycle.
 The Y-o-Y growth rate of investment expenditure was slashed to nearly half, growing merely at 11% in FY09 owing
to the credit crunch in the developed world, compared with over 20% growth seen in the previous 3 fiscal years.
 Government expenditure on the other hand spiked to 20% in FY09 and the upward trend in also maintained in
revival phase in order to support the economy and put the economic growth back on track.
 The catch here remains the consumption expenditure and recurring revenue expenses (as exhibited on page 6)
h d i l i l fl i i f h h l h h i i h h Thithat tends to remain relatively flat irrespective of the growth cycle that the economy is going through. This
stickiness or inelasticity in consumption demand and revenue expenses explains the widening twin deficits.
Growth rate of GDP components in varied growth cycles
FY11 FY12FY05 FY06 FY07 FY08 FY09 FY10
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GDP
Components
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Amount
(INR tn)
Y‐o‐Y
growth
Consumption
Expenditure 19.18 8% 21.53 12% 24.77 15% 28.41 15% 32.49 14% 37.08 14% 43.38 17% 49.62 14%
G t
FY11 FY12FY05 FY06 FY07 FY08 FY09 FY10
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Government
Expenditure 3.55 9% 4.02 13% 4.43 10% 5.13 16% 6.15 20% 7.74 26% 9.11 18% 10.36 14%
Investment
Expenditure 9.31 33% 11.20 20% 13.44 20% 16.42 22% 18.21 11% 20.42 12% 23.31 14% 26.15 12%
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Source: RBI and Altius research
Stable Increasing Decreasing

13. Changing share of GDP components in different Growth cycles
 Similarly the pie charts given below attempt to highlight the changing share of various components in differing Similarly, the pie charts given below attempt to highlight the changing share of various components in differing
growth cycles. The share of investment spending in the overall GDP also contracts from 37% in a boom period to
nearly 35.5% in a slowdown phase. Consumption spending also exhibits a similar trend.
 The boom phase components are an average of FY07 and FY08 owing to a real growth rate of over 9% recorded
in these years.
 Similarly, the slowdown phase considers FY09 and FY12 owing to the impact of credit crunch seen in the former
and the spill-over of European debt issues bogging down growth in the latter,
 FY10 d FY11 k d h i l h i l h i h i b d d 8% i h FY10 and FY11 are marked as the revival phase since real growth in the given years rebounded over 8% with
most components seeing a correction from the slowdown phase.
Foreign Trade
3 59%
Foreign Trade
‐5%
Foreign Trade
4 76%
Slowing exports widening Current
Account Deficit
Slow export, rebound in
imports widening CAD
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Investment
Expenditure
‐3.59%
Investment
Expenditure
‐5%
Investment
Expenditure
‐4.76%imports widening CAD
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Boom Slowdown Revival
Consumption
Expenditure
57.31%
Expenditure
36.95%
Consumption
Expenditure
56.86%
Expenditure
35.52%
Consumption
Expenditure
56.98%
Expenditure
35.97%
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Source: RBI and Altius research
Government
expenditure
10.31%
Government
expenditure
11.31%
Government
expenditure
11.93%
Public spending pickup impacting
Fiscal Deficit
Widening Fiscal Deficit

14. Linkage between GDP and Deficits
 The slowdown in growth that triggers high expenses by Inverse relationship between GDP & Fiscal Deficit The slowdown in growth that triggers high expenses by
the government to support the faltering economic
activity also impacts the deficit. The figure highlight
the correlation between GDP and Fiscal deficit, this
also shows FD curve a the mirror image of GDP 4
5
6
7
12
14
16
18
20
also shows FD curve a the mirror image of GDP
trajectory.
 Since the slowdown is a function of a drop in
manufacturing and investment activity, thus the
0
1
2
3
0
2
4
6
8
10
%
Direct relationship between Fiscal deficit & CAD
revenue mop-up drops as chunk of the capital flow
funds the revenue expense to maintain the
consumption momentum.
 Subsidised domestic consumption changes the DNA of
00
FY08 FY09 FY10 FY11 FY12
GDP at Market Price Fiscal Deficit as a % of GDP
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 Subsidised domestic consumption changes the DNA of
imports as demand for capital spending takes the
backseat. Stronger revival capability of imports
compared to exports, reeling under global crisis, adds
pressure to the current account balance
2.5
3
3.5
4
4.5
4
5
6
7
%
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pressure to the current account balance.
 Hence, the figure alongside establishes the direct
correlation between fiscal deficit and current account
deficit owing to identical trajectory of the two curves. 0
0.5
1
1.5
2
0
1
2
3
%
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Source: RBI and Altius research
FY08 FY09 FY10 FY11 FY12
Fiscal Deficit as a % of GDP CAD as a % of GDP

15. Fiscal Path  Committed v/s Expected
At a Glance FY12 (RE) FY13 (BE) (%) Nov-12 YTD (%) FY13 (AE) Change
Revenue Receipts 7,670 9,357 22 4,458 9,129
-Tax Revenue (net to Centre) 6,423 7,711 20 3,696 15 7,483 16.5%
1. Direct Tax 4,996 5,690 14 2,683 15 5,795 16.0%
2. Indirect Tax* 4,021 5,086 26 2,704 15 4,745 18.0%
-Non-tax Revenue$ 1,247 1,646 32 762 1,646
Capital Receipts 5,517 5,552 1 4,218 5,680
-Recoveries of Loans 143 117 -18 67 117
-Disinvestment 155 300 94 22 200 INR 100 bn (-)
-Borrowings and other Liabilities 5,220 5,136 -2 4,129 5,364
1. Market Loan 5,525 4,880 -12 4,205 5,108
D t d S iti 4 364 4 790 4 790a. Dated Securities 4,364 4,790 4,790
b. Bills and Others 1,161 90 318
2. Others -305 256 -184 -75 256
Total Receipts 13,187 14,909 13 8,676 14 14,810
Non-plan Expenditure 8,921 9,699 9 6,243 16 10,273 15.2%
-On Revenue Account of which 8 157 8 656 6 5 663 17 9 433 15 6%
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On Revenue Account of which 8,157 8,656 6 5,663 17 9,433 15.6%
1. Interest Payments 2,756 3,198 16 1,829 10 3,198 16.0%
2. Fertiliser Subsidy 672 610 -9 553 656
3. Petroleum Subsidy 685 436 -36 403 723 H1 UR INR 855 bn
4. Food Subsidy 728 750 3 728 750
-On Capital Account 764 1,043 37 580 7 840 10.0%
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p ,
Plan Expenditure 4,266 5,210 22 2,434 10 4,778 12.0%
Total Expenditure 13,187 14,909 13 8,676 14 15,051 14.1%
Fiscal Deficit 5,220 5,136 4,129 5,605
FD as a % of GDP 5.86 5.06 3.32 5.54
GDP 89,122 101,599 101,153
15
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INR bn Source: Finmin.nic.in, Indiabudget.nic.in and Altius research
AE: Total Expenses is BE + Supplementary grant of INR 308 bn; YTD (%) is cumilative Y‐o‐Y for 8 month ended Nov 12 over Nov 11 Numbers in INR bn
Incremental T‐bill issuance of INR 318 bn as on December 14; * Indirect Tax = Sum of Excise, Custom and Service; $ Expected spectrum sale to meet BE by March
Diffrential of Total Expenses over Total Receipts is the incremental issuance that can come though any of the two marked source

16. Key Takeaway

17.  Gold and Petroleum products cumulatively occupy nearly 40% of the total imports Thus reigning in the duo can
Dealing with Deficit
 Gold and Petroleum products cumulatively occupy nearly 40% of the total imports. Thus reigning in the duo can
improve the merchandise trade balance substantially. Addressing the non-planned revenue spending would also
improve the fiscal balance by capping subsidy bill to 2% of GDP in medium term, helping to inch towards the
committed consolidation of Fiscal deficit at 3% of GDP by 2017.
 The revival of investment activity may also play a major role in boosting economic growth. The same has been
attempted via approval of big-ticket reforms that is aimed at facilitating domestic manufacturing and investment.
 A major factor to revive the economic activity remains the interest rate environment. Thus a likely cut in interest
rate by the monetary authority may help in buoying business sentiment taking the pressure off the government’srate by the monetary authority may help in buoying business sentiment taking the pressure off the government s
shoulders to support economic growth.
Committed Fiscal pathTrade Balance as a % of GDP
FY07 FY08 FY09 FY10 FY11 FY12 FY13H1
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4
5
6
7
6
‐4
‐2
0
FY07 FY08 FY09 FY10 FY11 FY12 FY13H1
%
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0
1
2
3
%
‐12
‐10
‐8
‐6
%
17
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Source: PIB, RBI and Altius research
0
FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Actual Fiscal Deficit Targeted Fiscal Deficit
Trade balance Trade Balance ex‐gold
Trade Balance ex‐ Net Oil Trade Balance ex‐Net Oil & Gold

18. Risks to Deficit trajectory
 Recession in developed world With the European Union reeling under the textbook definition of a recession Recession in developed world- With the European Union reeling under the textbook definition of a recession,
the impact of the same has derailed the growth in some of the fastest growing Asian economies, viz., China and
India. Although, the Indian economy on back of government’s spending spree managed a revival in FY10 and FY11,
but the ability to sustain and grow when fiscal consolidation take center stage over next 5-years amid the
p e ailing t moil in de eloped economies ill be a da nting task (Anne e fig es 1 and 2)prevailing turmoil in developed economies will be a daunting task. (Annexure figures 1 and 2)
 Domestic macros- Food security bill scheduled to be passed and applicable since next fiscal, the upcoming
budget remaining populous in view of the 2014 elections, domestic monetary policy will continue to influence the
fiscal and trade balance.
 Global fiscal policy enigma- As global central banker strive to pull back their respective economies from slump
through the means of monetary easing, the translating impact on global commodity prices will percolate in
imported inflation for India. This can harness the domestic central banker willingness to ease monetary policy in
next financial year
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next financial year.
 The Double edged sword- The ability of Indian government to completely deregulate petroleum products seems
like a never ending fight owing to the threat the same bears on economic an geo-political factors, however,
regulation of petroleum products poses as a major roadblock to its targeted fiscal consolidation aim.
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 Global crude oil prices- The geo-political issues in middle-east that has constantly pushed global crude oil prices
well above USD 100/bbl coupled with rupee weakness may continue to exert pressure as far as the subsidy bill is
concerned.
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19. Annexure
Division of India’s export destinations (Fig 2.)Share of OECD nations in India’s export destination (Fig 1.)
60
70
80
90
100
60
70
80
90
100
10
20
30
40
50
60
%
0
10
20
30
40
50
%
0
10
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Total OECD % Total OPEC %
0
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
All EU countries % All North American countries %
All Asian & Oceania countries % Other OECD countries %
Merchandise trade trajectory growth (in USD mn) (Fig 3.)
60
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j y g ( ) ( g )
30
40
50
60
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‐10
0
10
20
Y08Q1
Y08Q2
Y08Q3
Y08Q4
Y09Q1
Y09Q2
Y09Q3
Y09Q4
Y10Q1
Y10Q2
Y10Q3
Y10Q4
Y11Q1
Y11Q2
Y11Q3
Y11Q4
Y12Q1
Y12Q2
Y12Q3
Y12Q4
Y13Q1
%
19
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Source: RBI and Altius Research
‐30
‐20
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
Export Y‐o‐Y Import Y‐o‐Y

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