The government looks like a batsman wanting to play only copy-book orthodox shots in death overs of a T20 cricket match. The wherewithal and the government’s ability to spend are far better now than when we last faced sub-5 per cent growth. Yet, the government seems morally shackled, ideologically paralysed and unaware of its fiscal strengths.
The virtuous looking dogmas that are sustaining the present pall of gloom are that the fiscal deficit targets given are inviolable, and the present situation does not call for any counter-cyclical action due to shortcomings in FRBM Act and/or the recommendations of its Review Committee; the inflation targets (around 4 per cent, +/- 2 per cent) developed by the RBI are a kind of moral or constitutional obligation; lack of clarity on how better prices mean better welfare for the people; and the masochist pride over currency values — the thinking is that an overvalued currency is a sign of strength.
The assumptions behind the false pride attached to currency values and welfare effect of cheaper prices need to be shed. We will see how despite the vastly superior financial firepower at its disposal, the economy is unable to take benefit of it — such inaction seems to be the root cause of the problems. The assumptions concerning fiscal and inflation bounds need to be revisited by more pragmatic economists.
First, let’s take the monolithic way inflation targets that have been prescribed. It will be tough to find in economic history how a fledgling economy trying to graduate from being low income to low-middle income contained its inflation at 3-4 per cent, or one which grew at 7-8 per cent with such low inflation consistently. Any growth will expand demand, which will mostly increase prices while interacting with an upward sloping supply curve. Even the current excess capacities will require better prices to restart supply.
There are no flat supply curve commodities, especially with people’s growing quality and brand consciousness. The more demand grows, the more inflation is likely to rise. To prescribe a 4 per cent central rate and follow it up with a hysterical reaction when the economy gets close to it is a sure way of suppressing demand. It appears that over the last 3-4 years, the low inflation target of 4 per cent has pulled down our growth rate to 4-5 per cent.
No doubt, the poor need protection. But when the same poor are borrowing at a 3.5 per cent interest rate per month, targeting inflation at 4 per cent to protect them seems absurd and ill conceived.
Second, let’s look at the fiscal deficit targets. The dissent note of the former CEA points out several lacunae in the approach and final recommendations of the recent FRBM Review Committee. The report is neither comprehensive, nor does it deal with appropriate countermeasures for various contingencies. The 3 per cent wait either way before the government can act is far too wide; and, as the former CEA noted, it both magnifies overheating and further depresses an economy in distress.
The government has to be complemented for the way it has built the balance-sheet strengths of the economy, but the cost it is paying is too much in current terms. Chart 1 calculates the revenue receipts, expenditure and subsidies as a percentage of the GDP for the decade between 2008-09 and 2018-19, and compares how these measure up if 2008-09 is the base year. As can be seen, revenue receipts of the Central government have fallen by 5 per cent, but expenditure has fallen by 20 per cent and subsidies by 32 per cent.
Even if the fall in subsidies is due to the plugging of leakages, it still entails a contraction of government expenditure going into private hands. Moral issues aside, this will have its economic impact. The Central government’s capital expenditure has moved in a narrow range (albeit downwards), and has not compensated for this impact.
The government’s fiscal rectitude has of course brought down its debt from 56.1 per cent to 47.8 per cent, and fiscal deficit from a high of 6.46 per cent to 3.34 per cent today. This is commendable, but it has also taken its toll.
The difference between the nominal growth rate (g) and the (nominal) interest rates (r) in which the government borrows is an important measure of how sustainable the deficits can be, and ‘g’ is most likely higher than ‘r’. The government’s ability to raise taxes is a function of the nominal GDP, but it has to pay ‘r’ to sustain such deficits. But as Chart 2 shows, despite our great fiscal restraints, this gap has been on continuous decline, reflecting an unexplained inability of the government to use its strength to bring down yields on government securities.
One reason for this may be the ‘black’ fiscal deficits — amounts parked outside through extra budgetary resources or instruments issued by Central government-allied institutions, which compete for the same kitty as the Central government’s debt on eligibility criteria. And if there are multiple agencies placing essentially the same instrument, the pricing power of the Central government takes a beating. It may be more prudent to consolidate the black and white fiscal deficits and manage them as one, even if this seems irksome in the short run.
Given its enormous strengths, the government should be bold enough to cast aside (at least for sometime) the needless and contextually out-of-sync inflation and fiscal targets and really try to revive the economy. The government can as a first measure raise up to 1-2 per cent of the GDP and clear all its pending bills (to NHAI contractors, fertiliser subsidies and capital expenditure payments for railways and defence), to manage fiscal numbers. Since these expenditures have already been incurred in the past, it is most likely that there won’t be inflation from them.
It is hoped that the government overcomes academic impositions with practical actions.
The writer is author of Making Growth Happen in India.