Fiscal policy in India is now far more multi-dimensional than the troika of tax, subsidies and fiscal deficit
Moody?s Analytics has recently taken on the RBI Governor for apparently suggesting that India could come closer to double-digit growth. The arm of the rating agency is concerned that without advocating structural reforms, pushing the pace of growth will overheat the economy.
While this is an obvious point, one even RBI has made on several occasions, the mistake Moody?s makes is in evaluating the role of the government in the Indian economy. Most foreign commentators have looked at the troika of fiscal deficit, the subsidy bill and the projections of aggregate receipts to sum up their observations. While these are significant numbers, the impact of the federal budget in India cannot be made out through these numbers. It is sort of equating the exercise to the RBI monetary policy action.
Since the monetary regulator has only one instrument, which is the interest rates, the impact has to be measured with reference to it. But fiscal policy in India is even now far more multi-dimensional than the troika of tax, subsidies and fiscal deficit.
The Indian government action on the economy is far better captured by measuring its impact on the consumption story. This was wonderfully demonstrated by the impact of the Sixth Pay Commission for central and state government employees.
In 2008-09, when the G20 economies decided to give a joint boost to their economies by fuelling expenditure, India was hamstrung. The government had already gone in for a 24% rise in aggregate expenditure and so its room for further manoeuvre was extremely limited. It was, however, saved the trouble by the award of the Pay Commission that came in 2008, which almost doubled salaries in many grades. In July 2010, the Centre decided to make it better by allowing the employees to choose the date from which they would want to revise their pay as per Sixth Pay Commission scales. By the Commission?s own estimate, this created an additional payout of R20,000 crore on the Centre, plus the impact on the state government.
This was fiscal profligacy all right, but it worked. The cascading impact on the rest of the economy was significant. This was captured by the FMCG sector and even in the demand for consumer durables, all of which rose handsomely. Since, in the same year, the inflow into the small savings, including the most popular one, the Public Provident Fund, galloped to R24,489 crore (2009-10 and 2010-11) compared to a negative balance of R1,302 the year before, there was little to crib about savings and thereby investment. The savings rate of the economy rose to 34% in the process in the same year.
So, what are the comparable measures to analyse the impact of the Budget on the rest of the economy. I would submit these are the measures of total expenditure and, within that, the segment of non-Plan expenditure along with the extent of public debt.
The Indian government is far better at pushing the rupee into the hands of the citizens instead of working as an investment manager on their behalf. The fund managers from abroad are under the assumption that a government serves the economy better when it restricts its footprint. A lower deficit, lower receipts and lower subsidies are part of the same argument. This is an assumption that the Indian economy is still far from fulfilling. But following this line of thought leads to an expectation about the final impact of the Budget that is often quite different from what analysts come to expect. A government as a consumption multiplier for the economy obviously has its limits, but there is still some headroom left for now. The expenditure on government staff helped spur demand in the economy, and the borrowing to meet this expenditure shored up the balance sheets of public sector banks till recently, in the form of their treasury income.
For instance, in 2011-12, of the total government expenditure, 20% was on consumption, while that on gross capital formation was only 5.4%. Not only is the capital component of the government budget puny, it is spread across too many departments to be a force multiplier in any appreciable way. Budget 2013-14 lists 57 departments where the estimated R1,74,656 crore allotted will end up.
Compare this with another indicator?the level of transfer payments from the government to the rest of the economy. In 2012-13, it is projected at 67% of total government expenditure, almost four-fifths of which is consumption expenditure.
Are these high levels of transfers creating long-term damage to the economy? If one analyses the level of public debt the government has built up to finance this level of expenditure, it does not seem so. As on March 31, 2012, the total public debt of the Centre was about 54% of GDP and in 2014 it is expected to be 56.7%. As a sampler with the IMF figures for the corresponding emerging economies shows, these are impressively low numbers.
As I said earlier, the concerns about the deficits are real. There are already drags surfacing on the way government operations like additional entitlements would impact the economy. Yet, till now, the Indian government has worked best as a consumption multiplier but rarely as an investment multiplier. It has consequently worked out the non-Plan elements more impressively.
These are the elements that deserve far more attention than the facile arguments about growth with or without structural reforms. For instance, a possible reform is the impact of changes in the public distribution system. It will, however, lead to the closure of many ration shops that play on the price arbitrage between issue price of grains and the market price. This would be more visible in the low per capita income states and could have a short-term negative impact on the rural economy. So, all reforms are not immediately growth-inducing. Without analysing such myriad factors, getting a grip on the process of fiscal arithmetic in India would lead to a cul-de-sac.
subhomoy.bhattacharjee@expressindia.com