Column: The crisis of credibility

The demand for relaxation of the fiscal deficit target raised in the Mid-Year Review is worrisome

Let me wish readers a very happy New Year! Hopefully, the New Year will usher in better policies towards accelerating growth and ensuring development of the country.

The budget exercise is under way and it is time to build expectations. The most important expectation from the viewpoint of reviving the economy is the fiscal stance in the forthcoming year, after postponing the consolidation programme last year. The Mid-Year Review, articulated by the Chief Economic Advisor, has called for reassessing the fiscal consolidation process as well as reconsidering the monetary policy stance for the coming year. It has called for reviewing the medium-term fiscal framework to relax the fiscal targets as private investment and exports have failed to revive demand to the required extent and nominal GDP growth has tended to fall behind the real growth making it further difficult to adhere to the path of reaching the fiscal targets. The Review argues that, with taxes not very buoyant, disinvestment receipts not materialising due to the subdued capital market and the possibility of phasing out subsidies exhausted, the only way to revive the economy is to expand government investment financed by borrowing. The Review questions the rationale for continuing with pro-cyclical fiscal policy stance. On monetary policy too, in view of the severely adverse debt dynamics of the private corporate sector, the Review makes out a case for a more gradual path to reach the inflation target or more accommodating interpretation of the inflation objective.

All in all, the Review wants greater fiscal space by relaxing the additional 0.6 percentage point reduction in the fiscal deficit indicated in the medium-term financial plan (MTFP) target and lower interest rate regime through greater accommodation in monetary policy.

These demands, coming from the Chief Economic Advisor, are worrisome. There was a similar demand last year and fiscal adjustment was postponed, and instead of sticking to the target of 3.6%, the fiscal deficit was set at 3.9%. If, indeed, private investment has failed to take off, it is as much due to high fiscal deficits as it is due to the inability of the government to ease the supply-side. Of course, easing the supply side to activate the private investment cycle should have been the priority and this did not hinge on political impasse. Hopefully, with Kelkar Committee’s report on Public Private Partnership (PPP) now available, the government will move decisively to initiate measures to revive the stalled projects. There are a number of policy measures that will be needed to clean up the balance-sheets of private firms. There is also a great deal of reluctance by the public sector financial institutions to lend as their own balance-sheets are under severe stress. There has not been much of the change in the tax governance; concerted action to rekindle private investment activity—both domestic and foreign—is necessary.

The problem is that the fiscal deficit is far too high and the assertion that public investment financed through borrowing will crowd in private investment is not supported by any evidence. This year, the Union government’s deficit is set at 3.9%, and with the states together having a deficit of about 2.2%, the aggregate fiscal deficit of the government works out to 6.1%. It is reported that 21 distribution companies are likely to join the UDAY scheme and the deficit on that account could be about 1%. With the public sector enterprises claiming about 2% of GDP, where can financial institutions find the money to lend for private investment? With the nominal GDP growing at a slower rate than the effective interest rate, and at a time when the primary deficit is already high, resorting to further borrowing will only add to the debt burden and make the fiscal deficit unsustainable. Interest payments already claim almost 50% of the net tax revenues and about 40% of the net revenues of the Union government; the country can ill afford to spend so much of revenues on debt-servicing. Where is the credibility of the government when it flouts its own MTFP targets time and again?

On the supply-side, there is not enough money to lend to the private sector. The household sector’s financial saving is estimated only at 7.5% of GDP. With 21% of the demand and time liabilities of the banking system being pre-empted by the statutory liquidity ratio (SLR), 6% due to cash reserve ratio (CRR), and another 15% for priority sector lending, increase in government deficit can only push up the interest rate, and rather than crowding in, it will financially crowd out private investments. There are further constraints on the supply-side. Even when RBI reduces the interest rate, it fails to transmit in terms of lower lending rates. Here, the downward inflexibility is because, apart from the rationing of the demand and time liabilities, banks are faced with the downward inflexibility in the interest rate on deposits. As the rate of interest on small savings and public provident funds are determined administratively, commercial banks have to pay competitive interest rates to attract deposits and that also imparts downward rigidity.

Further, given the overhang of the large non-performing loans, banks, particularly in the public sector, would prefer to lend to the government or public sector companies and not to the private sector. In this environment, it is doubtful whether asking for lower fiscal deficit or lowering the interest rates would revive the private investment cycle. Foreign investment continues to be sluggish due to poor infrastructure, difficulties in doing business in India due to several clearances required from Union, state and local governments, and unfriendly tax governance. The need of the hour is not slogans, but action on the ground.

It must be admitted that the low oil prices have come as a great boon for the government and much of the fiscal consolidation achieved has been entirely due to that. The government has also done well to increase the excise and customs duties of oil to mop up revenues. In the given environment, it is true that government investment will have to be increased, but not fiscal deficit. There is considerable scope for rationalising expenditures, including subsidies and transfers. There is no case for continuing with large subsidies on urea. Rationalising travel policy and closing down companies like Balmer Lawrie can bring in substantial savings which can be used for investments. The 14th Finance Commission, in its report, has recommended that disinvestment and dividend policy on public enterprises should be guided by the prioritisation and this could garner significant amount of idle funds from the public enterprises. The future generation needs more spending on education and health, and not doles.

The author is emeritus professor, NIPFP, and adviser, Takshashila Institution. Views are personal.

This column will now appear on the first Tuesday of every month

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