The Modi government began with fiscal pause to spur a recovery, and now ends doing the same with higher interest rates
How does one reconcile a picture of robust economic growth—an average 7.7% over FY15-FY18—with regular fiscal slippages in the name of supporting growth? If that sounds incompatible, it is. But this inconsistent strand can be seen through the tenure of the current government: On the one hand, strong growth claims have been burnished with a retinue of related achievements. Yet, on the other side, the government has consecutively deviated from the fiscal roadmap in all but one of its five-year tenure to date in order to revive the economy!
The interim budget for 2019-20 continues in the same vein. The government overshot its budgeted fiscal deficit target (3.3% of GDP) once more, keeping it at 3.4% for this year and the next. The medium-term deficit target of 3% of GDP, initially to be achieved in 2016-17, remains elusive and is now pushed further to 2020-21. This time, the fiscal slippage is to accommodate a direct income support package for farmers (Rs750 billion annually, 0.36% of GDP) to alleviate their distress, and tax-breaks for middle-classes aggregating 0.1% of GDP.
A 14.4% increase in current spending (11.7% of GDP) compares with 6.2% growth in capex (1.6% of GDP), with the share of the former in total expenditure reaching 88%. Major subsidies (food, fuel and fertilisers) add up to 1.4% of GDP, unchanged from revised FY19 figures but significantly above 1.1% of GDP in FY18. How much of subsides are unpaid, rolled-over needs careful parsing; past trends show that the amounts are substantial.
Apart from Rs7.1 trillion of fresh market borrowings in FY20, the government expects to finance the enlarged fiscal deficit with fair amounts of optimism on taxes. Overall tax buoyancy works out to 1.29, which looks difficult to achieve. Indirect tax and non-tax revenue assumptions are much more optimistic: GST revenue buoyancy is assumed at 1.58, which compares with anticipated shortfall of Rs1 trillion this year; dividends and profits are projected to increase 14% over a 31% increase in FY19 (current year’s target yet to be achieved); and Rs900 billion worth of asset sales (Rs800 billion target for this year not reached so far). Past year’s performance comparisons apart, the slowdown in global growth and trade in 2019 with financially volatile conditions cast further doubts that these targets are credibly achievable.
Much of this remains up in the air, but enduring commitments have been made. The expansionary thrust will no doubt lift disposable incomes, counter the slowdown in private spending to some extent and buy goodwill ahead of elections. What it does to interest rates and private investments is another matter. The bond market response testified—the 10-year benchmark yield jumped 14 basis points to close at 7.62% as the news sank in. It is notable that bond yields remain firm despite continued open market buying by the Reserve Bank of India. Of equal concern is the build-up of off-budget liabilities and extra-budgetary financing—analysts estimate these add up to about 2% of GDP—which additionally squeeze out the private sector from accessing capital resources.
From a monetary policy perspective, the interim budget is expansionary, tilted towards consumption and inflationary. Two instalments of the direct cash transfers to an expected 120 million farmers (with effect from December 2018) could be paid by March 2019; at this end of the income pyramid, the marginal propensity to consume tends to be large. To be sure, with headline inflation ruling in the 2-3% region, the Reserve Bank of India is likely to change its stance to ‘neutral’ but may hold the policy rate seeing the rise in inflation risks, persisting strength in core inflation and closing output gap.
The unfortunate part is that ‘more-of-the-same’ fiscal thrust for five consecutive years is visibly manifest in crowding out of private business spending even as the whole point of stepping off the fiscal consolidation path has been to bring it back. A striking indication of this is the confluence of historically low inflation and high interest rates. The extent of government spending support in this period needs to be seen in conjunction with exceptional windfall of oil-tax revenues, accumulated off-budget liabilities and extra-budgetary resources raised by the public entities whose principal and interest payments devolve upon the government’s budget. Revised estimates show central government debt at 48.9% of GDP in 2018-19 against budgeted 48.8%, but this does not include financial liabilities incurred by PSUs—in FY17, total liabilities aggregated Rs3.05 trillion or 2% of GDP as per the CAG’s report and have surely risen significantly since. Rising interest rates with falling inflation could regenerate debt sustainability concerns on the part of rating agencies.
-The author is a Delhi-based Economist