A day after NITI Aayog vice-chairman Arvind Panagariya spoke of the need to relook the CPI-inflation target of 4± 2%, chief economic advisor (CEA) Arvind Subramanian has added to this, the need to relook fiscal deficit targets and go for a more expansionary fiscal policy. With nominal GDP decelerating sharply to 8.2% this year as compared to the budget target of 11.5%, he says in the mid-year review of the economy, this will push up the national debt-to-GDP ratio and, in the case of India Inc, the flat topline will also make it increasingly difficult for highly-leveraged private firms to repay loans. Apart from that, the lower nominal GDP means the government has to cut its FY16 deficit by around R25,000 crore if it is to stick to the 3.9% target—assuming no slippage in taxes or divestment, this means a sharp cut in spending. Since, the CEA says, two of the engines fuelling the economy in the past—exports and private investment—are not available in the short run, the onus has to fall on private consumption and public investment; the latter is vulnerable to some serious downsizing if commitments to fiscal discipline are to be kept. Since there is little capex likely from the private sector for at least another year or two, it is important the government keep up the pace of investments—in H1FY16, it spent R1.28 lakh crore, an increase of 44% year-on-year; taken together with the states, aggregate government capital expenditure is up a whopping 0.5% of GDP. Fresh public investment would create jobs and put more money in people’s pockets, required to keep private consumption levels up. If this is not done, FY17 could turn out to be even less ordinary than FY16.
Also, with the Seventh Pay Commission likely to add 0.65% of GDP to government expenditure, the government’s ability to raise fresh resources will also be constrained in FY17—hiking duties in the automobile sector along with those in the petroleum sector netted extra taxes of around 0.3% of GDP in FY16 so far; if oil prices continue to fall, there is a possibility of taxes remaining buoyant in FY17 also as more levies could be imposed, but low oil could further hit both exports and also remittances. Also, as Subramanian points out, if oil prices don’t fall more, the earlier gains to private disposable incomes will soon fade away—creating sustainable consumption demand will need some monetary policy support.
While Subramanian talks of the need for ‘flexibly interpreting inflation targets and the glide path’ given the possibility of higher inflation due to relaxed deficits—especially if global deflation abates—over the longer-term, interest rates need to be brought down. With the difference between the base lending rate and nominal GDP growth now 4%, both the government and the private sector are in danger of getting caught in a debt trap as long as interest rates are higher than nominal growth rates. Asking RBI to relax its CPI targets is one option, but what is more important is cutting interest rates on small-savings schemes so that banks can lower interest rates on deposits and transmission will be faster.