Growth, not blind adherence to fiscal rules, is the best antidote to an ailing economy : 04-02-2020

Be careful what you wish for. Finance minister Nirmala Sitharaman’s budget on Saturday ticked almost all the boxes on the market’s wish list.

Yet, the Sensex tanked, ending the day close to 1,000 points lower, the highest post-budget fall in almost five years.

Not that market reaction is ever a true yardstick of the worth of a budget.

Budgets are best viewed through two prisms. One, that of policy direction — does it set policy in the right direction, if necessary, by making course-corrections? Two, that of fiscal discipline. On both counts, Budget 2020 does a reasonably good job.

On policy direction, it indicates Go-I’s willingness to support the economy with capital expenditure — capex is projected to rise 18%. On fiscal discipline, it acknowledges the inevitable — a rise in fiscal deficit (FD) to 3.8% of GDP in FY20, the fallout of a severe economic slowdown, and using the leeway given in the Fiscal Responsibility and Budget Management Act (FRBMA) — and promises a return to the glide path by 2023.

The message, as St Augustine put it in the 4-5th century, is ‘Give me chastity and continence, but not yet.’

Growth, not fiscal fundamentalism, is the best antidote to a host of ills, economic and social. GDP growth, going into the latest budget was just 5%, lowest in 11 years (the statistical bump-up to 5.7% came on the eve of Budget 2020), growth in private consumption was 5.8%, lowest in seven years, investment growth was 1%, slowest in 17 years, manufacturing growth was 2%, lowest in 15 years.

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In a scenario where government spending is the only game in town to keep the wheels of the economy turning, blind adherence to an arbitrary fiscal rule would have been not just unwise, but also foolish.

This is not the first time GoI has reset the fiscal clock. We have lived with FDs as high as 6% and 6.4% in 2008-09 and 2009-10, respectively. Sure, much of the pain being experienced today could be laid at the door of those fiscal and monetary stimulus packages. But these are more the result of them not being withdrawn in time. In contrast, what we have today is a clear commitment (that, admittedly, must be taken at face value) of a return to fiscal discipline, but in a phased manner.

Fiscal Deficit
Agreed, the true FD is higher. An annexure lists out all the sleights of hand that have, historically, accompanied budget numbers. If one includes these off-budget items — borrowings financed from the National Small Savings Funds, expenses rolled over to the next year, etc. — FD goes up, but not astronomically, to 4.8% for FY20.

Moreover, the usual fears about high FD — that it will push up interest rates, since sovereign borrowing sets the floor for risk-free interest rates in the economy and crowd out private investment — don’t apply today. Yields on 10-year government securities are lower, in both real and nominal terms, with nominal rates almost 100 basis points (one basis point is 1/100th of a percentage point) lower than in July 2019. Indeed, FY20 interest payments are significantly lower than budget estimates, despite higher borrowings.

As for crowding out, the combination of a demand-compressed economy and lending-shy banks has seen credit growth fall to a record low of 7%, with banks preferring to park excess funds with RBI rather than lend. So, even though both net and gross market borrowings by GoI are projected to increase in FY21, markets will be able to live with the increase.

Rating Agencies
Turn now to fear of rating agencies. What is India’s track record on FDs and ratings? Surprise, surprise! India’s long-term foreign currency rating has been constant at BBB- (Standard & Poor’s) since 2007, even as FD declined from a high of 6.5% of GDP (2009-10) to 3.9% (2015-16). Ironically, the outlook moved up to ‘stable’ in March 2010, after FD touched 6% in 2008-09 and fell to ‘negative’ in April 2012, within months of the FY13 budget projecting lower fiscal deficit, before going back to stable in September 2014.

This is not to say FDs are irrelevant.

But there is a fine line between fiscal profligacy and fiscal pragmatism. Astute fiscal management is about drawing that distinction. When growth is below potential, there is a severe infrastructure deficit and underutilised capacity, and it is about taking a more nuanced view of FDs — not about being cowed down, whether by rating agencies or bond market vigilantes. Or by, dare I say, strident op-ed writers.

Today, the problem is not with a higher FD. Rather, it is with the quality of FD. If the additional expenditure (borrowing) is for capital expenditure, there is no issue. Unfortunately, that is not the case. The revenue deficit — a measure of how much borrowing is going to finance current consumption — is projected to increase from 2.4% of GDP in FY20 to 2.7% in FY21. Worse, its share as a percentage of FD is slated to increase from 63% in FY20 to 77%, suggesting more, rather than less, of GoI borrowing is going for non-capital expenditure. This needs to change.

Macroeconomics is like medicine. When the patient is in critical care, first administer the medicine then worry about side-effects. Especially when side-effects are neither definite nor uniform and, with some luck, can be managed.

Source : PTI