Chief economic advisor Arvind Subramanian makes a powerful point when, in a dissent note in the new FRBM committee report, he says the debt target of 60% of GDP is arbitrary, and the path to achieving it serpentine. While the committee talks of, on average, emerging markets with similar ratings as India having a debt/GDP ratio of 40% as compared to India’s 70%, Subramanian points out that India experienced its greatest-ever growth in the mid-2000s when its debt was 10 percentage points (ppt) higher than now. When, after the global financial crisis, many advanced economies crossed even the 100% debt-to-GDP that was previously considered dangerous, he adds, interest rates actually fell to historically low levels—while this suggests a focus on only debt levels is misplaced, it would appear the direction in which debt is moving may even be more important than its level.
And while the committee has done well to bring in the element of contra-cyclicality—spend more in a bad year and less in a good one—that was missing in the original FRBM Act, the triggers are too severe to really help; indeed, Subramanian argues they even aggravate the problem. If real GDP falls from 5% to just above 2%, it fails to meet the 3 ppt trigger allowed for a 0.5 ppt relaxation in the fiscal deficit target, and if GDP growth rises from 6% to just below 9%, once again, the trigger is not set off. In other words, the relaxations are not enough to allow more spending in a bad year or to slow spending in a good year. In a situation of weak growth, as now, the new FRBM doesn’t give the required flexibility to ramp up public spending. Nor is there any real logic to why, after a sharp 0.5 ppt compression in the fiscal deficit in FY18, there is a pause for two years or the subsequent path of compression.
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While economists will debate whether the committee has adequately countered Subramanian’s critique, the real issue is how to ensure the new targets are not ‘paused’ or put on ‘hold’ as they have in the past—the FY18 budget targets a fiscal deficit of 3.2% while the original FRBM saw a 3% level being achieved in FY09. The idea of an autonomous Fiscal Council—more than 35 countries have this—to monitor adherence to the targets and prepare independent reports on the government’s fiscal performance is a good one, but it can’t make the government stick to the target if it doesn’t want to; a debt ceiling embedded in the law is a possibility but would make India vulnerable to US-style government shutdowns. Since market discipline is required, lowering mandatory SLR requirements could be one way to make bond yields more responsive to central government debt levels though it wouldn’t help if, as now, SLR holdings of banks are much higher than what is even mandated. In the case of state governments, if some doubt was created over RBI’s complete back-stop to their debt, this would ensure states would be penalised for poor debt dynamics. Allowing more FII presence in debt markets would also impose more discipline since such flows are more sensitive to debt levels but RBI needs to examine the larger implications of how much volatility is desirable.