How to fund the fiscal stimulus needed to revive growth

The fiscal measures announced so far appear to be insufficient to protect the economy from the growth slowdown triggered by Covid-19 pandemic. Debate is raging about the additional economic package necessary to kick-start the economy. In a crisis like Covid-19, fiscal stimulus is inevitable and, therefore, fiscal consolidation has to be set aside, at least for FY21.

Many advanced and emerging economies have announced large fiscal stimulus to protect their economies. So far the government has announced ₹2 trillion fiscal support (including ₹30,000 crore under the PM’s Garib Kalyan Yojana). Before suggesting any fresh stimulus, it would be appropriate to revisit the likely level of fiscal deficit this year as the Budget numbers are no more relevant.

Revenue shortfall

Revenue growth postulated in Budget 2020-21 is optimistic. Shortfall in revenues this year may be unusually large due to the sharp slowdown in growth following Covid-related lockdowns. Similarly, the disinvestment target in the Budget, at ₹2.1 trillion, is challenging even otherwise. In the changed circumstances, the disinvestment target will be extremely difficult to achieve as the capital market is unlikely to rebound quickly. Hence, shortfall of resources on these two counts may be at least ₹2 trillion in 2020-21.

The gross fiscal deficit (GFD) proposed in Budget was nearly ₹8 trillion, which may escalate to ₹12 trillion, which includes the stimulus already announced and the likely shortfalls in revenues/disinvestment.

In the 2020-21 Budget, nominal GDP was assumed to grow at 10 per cent to ₹224 trillion. Due to the extended lockdown, the loss of nominal GDP may be at least ₹10 trillion and nominal GDP growth is likely to be 5 per cent at the most.

This would push up the GFD-GDP ratio from 3.5 per cent to at least 5.5 per cent. If the government goes for additional stimulus of, say, another 3 per cent of GDP (₹6 trillion), then the GFD/GDP ratio may go up to 8.5 per cent. If you add State fiscal deficit of about 3 per cent, the Centre’s deficit would shoot up to 11.5 per cent of GDP and to about 12.5 per cent on including extra-budgetary resources (EBR), which are almost impossible to finance. Hence, a greater part of the fiscal pressure has been taken away by the monetary policy.

Pressure on yields

Despite the deep repo rate cut (75 basis points) and provision for massive liquidity injection of ₹3.74 trillion announced by the RBI on March 27 (CRR cut by 100 bps (₹1.37 trillion), TLTRO (₹1 trillion) and additional 1 per cent SLR exemption for borrowing under MSF (₹1.37 trillion)), the benchmark yield on 10-year G-Secs remains elevated.

Pressure on sovereign yield is also emerging from the extreme risk averse behaviour of FPIs due to flight to safety. The market has obvious limitations to absorb the enhanced borrowing programme. Even without further fiscal stimulus, about ₹4 trillion additional borrowing in FY21 — ₹2 trillion fiscal stimulus announced plus ₹2 trillion revenue/disinvestment shortfall mentioned earlier — has been factored in. Pressure on yield will be very high if government borrowings go up further. This will defeat the objective of accommodative monetary policy. Hence, room for fiscal stimulus is very limited in India.

As fiscal space is limited, the RBI announced second round of extra-ordinary monetary stimulus of ₹1 trillion on April 17, mostly targeted towards MSMEs, besides regulatory forbearance. Net absorption of liquidity under LAF was as high as ₹6.9 trillion on April 15. In order to persuade banks to lend, the reverse repo rate was reduced further by 25 bps to 3.75 per cent outside the policy cycle.

It is advisable to introduce deposit facility at the earliest on which the RBI may pay a very low rate of interest, say 2.5 per cent. Making funds available at repo rate (4.4 per cent) under TLTRO for on-lending to the target groups or even at MSF rate (4.65 per cent) under SLR exemption tantamount to implicit interest subsidy that relieves fiscal pressure. Further, large increase in the RBI’s domestic assets through innovative means, including large OMO purchases, could be interpreted as implicit monetisation of debt without violating rules.

Funding options

If fiscal stimulus is inevitable to deal with the growth slowdown, what are the alternative financing options other than market borrowing? These are: borrowing from the RBI — that is, monetization of debt; financing through EBR; sovereign borrowing from abroad in foreign currency directly or through PSUs; and negotiation of assistance from multilateral institutions and/or use of bilateral swap lines.

Firstly, monetisation of debt is not possible without amendment of the RBI Act. Secondly, this soft option may open the floodgates, which is not desirable under the inflation targeting regime. Thirdly, breach of monetary policy independence from the fiscal policy will kill many institutional arrangements that have been developed so assiduously over decades.

The government may increase income tax benefit under Section 80C from ₹1.5 lakh to ₹3 lakh for 2020-21. This may result in some loss of tax revenue, but will increase small savings significantly, which can be used as EBR to finance fiscal stimulus.

The other two options are external borrowings in some form or the other. Global interest rates, particularly in the reserve currency countries, being low, it is advisable to devise a suitable mechanism to borrow from abroad. Foreign currencies so obtained may be placed with RBI for domestic currency. This may increase the government’s external debt, which is otherwise not very high, but obviates the monetisation of debt. Bilateral swap arrangements and borrowing from multilateral institutions are the most preferred options as they carry very low interest rates.

The writer is a Visiting Fellow at IGIDR and former head of the Monetary Policy Department of RBI

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