India watchers are in for a triple treat in the coming months. This week’s Union Budget for 2019-20 will be followed by next week’s meeting of the monetary policy committee (MPC). The focus will then shift to the national legislative election, most likely spread over April and May. The Union Budget is the last one by the prime minister Narendra Modi’s government while the MPC meeting will be the first to be chaired by the new RBI Governor, Shaktikanta Das. The election outcome, along with its related political arithmetic, is anybody’s guess, but the fiscal-monetary mix to be navigated is very much within the control of policymakers.
There is practically no room to manoeuvre on the fiscal front while there is, at best, limited scope on monetary easing. Still, on the fiscal side, we should be prepared for political expediency slightly chipping away at economic responsibility, but a massive assault will be avoided. On the monetary side, the MPC will shift its stance to neutral and also cut the repo rate by 25 bps to 6.25%. Its cautious guidance will effectively signal scope for limited monetary easing, provided the inflation outlook offers that flexibility (which it will, in my view).
The government will likely meet the fiscal deficit of 3.3% of GDP for 2018-19, despite the sizeable shortfall in GST collection. This would be achieved thanks to a sizeable interim dividend from RBI, coupled with the usual cash accounting tricks, including delayed subsidy payments, used by successive governments irrespective of their political hue. RBI’s interim dividend isn’t unusual, but its size this time could raise eyebrows.
Of course, these gimmicks raise legitimate questions about the quality of the underlying fiscal adjustment, but that is hardly a new issue. The fact of the matter is investors and sovereign credit rating agencies have come to accept the low quality and now often don’t even raise these issues when they must. Consider the following: India’s reported fiscal deficit of the Central government is understated because it counts divestment and asset sales as revenues instead of as financing items, as is the IMF’s best practice.
Also, there has been increasing reliance on off-budget financing of capital expenditure in some sectors, such as roads and railways, via quasi-government entities. Add to these the widening of the state-level fiscal deficit and it is hard not to conclude that the consolidated fiscal picture—which is what matters for macro management—is far from inspiring. The IMF estimates India’s general government debt at an elevated 70% of GDP; it has risen since 2014.
Surpassingly, off-budget financing has hardly been as much of a focus as it should when the Union Budgets are announced. For the record, even the MPC and the RBI’s financial stability assessment look the other way. The only reason it has captured attention now is because of the recent uncomplimentary observations by the Comptroller and Auditor General.
For 2019-20, the government will probably peg the fiscal deficit in the range of 3.1-3.3% of GDP (prior target: 3.1%) and reiterate being “firmly”on track to achieve the already announced forecast of 3% in 2020-21. This should keep the MPC satisfied about fiscal consolidation, though recall that achieving the 3% level has been delayed by two years. The marginal slippage shows poor fiscal discipline and is in sync with past behaviour, but is hardly the end of the world. For what it is worth, the officially reported Central fiscal deficit/GDP has shown an improving trajectory, but over a longer time period than initially planned.
The big idea in the Budget 2018-19 will be the announcement of a cash transfer scheme to complement other measures for the distressed agriculture sector. Some measures could be announced before the Budget. It is being widely overlooked that the government doesn’t need to compress the role out of the scheme within one fiscal year. Tactically, it’ll play up the idea in this Budget and begin its implementation in a small manner, probably by subsuming some subsidies, but complete details will emerge in the full Budget after the general election.
The government has to be extra careful in that the cash transfer scheme cannot be a sizeable additional expenditure on top of the current spending on subsidies. More generally, the initiative follows the pattern of governments committing to recurring expenditure with a silent prayer that revenue collection will improve on a sustained basis to pay for it. This time, a one-off gift, probably spread over a few years, from RBI is awaited to complement traditional revenue sources. The merits, the feasibility and the economic implications of this notwithstanding, the approach is in line with governments’ questionable practice of using one-off divestment proceeds to finance recurring spending.
Separately, several factors give the upcoming MPC meeting an exceptional flavour. Firstly, it will be the maiden meeting chaired by Governor Das, who was practically parachuted by the government following the unceremonious exit of his predecessor. Second, the MPC will likely lower its forecast for GDP growth and inflation; thirdly, international crude oil prices remain well below their peak in October; fourthly, the US FOMC is likely done, or is very close to being done, with raising policy rates. Finally, at 2.2% in December, headline CPI inflation has been below the medium-term target of 4% for five consecutive months and will remain so for a few more.
The MPC needs to appreciate that its legally mandated target is headline CPI inflation, not the core measure. Admittedly, the drivers of headline inflation have to be analysed and their sustainability gauged for designing the appropriate policy response. However, there is a perception that the MPC’s emphasis on headline versus core inflation flip-flops inconsistently.
To be sure, core inflation has eased but is still uncomfortably high, and the slump in food inflation won’t be sustainable over the medium-term. Trend economic growth has edged down in recent years and the near closure of the output gap suggests negligible scope for aggressive monetary easing. However, these don’t eliminate the scope for a couple of rate cuts in the very near-term, partly also because real interest rates are high. The MPC is already late in shifting its monetary stance and in cutting rates, in my view.
The MPC should offer insights on the exaggerated impact on core inflation of the narrowly based high inflation in health and education services. The oddity of the latest unexpected—but also narrowly based—jump in rural core inflation despite the pronounced agrarian/rural weakness also warrants an explanation. If high core inflation is because the output gap is closing, why is the magnitude of that impact uncharacteristically large? If not, how reliable is the measure of core inflation for playing an indirect role in calibrating the monetary response function? The MPC has its work cut out.