There is no agency in the government that looks comprehensively at both Central and state, fiscal costs and revenues, and relating them to the fiscal rules that the country has enacted.
A fog has set over New Delhi: the fiscal outlook for the medium term seems unclear. With the Centre bringing down its primary deficit meaningfully, its debt has been falling. On the other hand, the aggregate state primary deficit has risen meaningfully (from 0.4% in FY12 to 1.3% in FY18). And, more importantly, its borrowing costs have been soaring. Last year, when the much-needed new fiscal rules (Fiscal Responsibility and Budget Management—FRBM) were enacted in Parliament (in March 2018), public debt was made the main anchor of the fiscal framework. They stipulated that the Centre’s debt should not exceed 40% and the overall Centre plus states’ debt should not exceed 60% by the end of FY25, down from over 70% now. Based on these assumptions, only if the overall government cuts its fiscal deficit by 1.4 percentage points (from 6.4% GDP in FY18 to 5% of GDP) will it be able to reach the 60% debt target by FY25. If divided equally, as suggested by the new FRBM, both the Centre and the aggregated states should run deficits of no more than 2.5%, each, by FY25.
The inconsistencies in expenditure began when several new spending plans with substantial fiscal costs were announced. In an effort to address rural slowing, about 10 states announced farm loan waivers worth about `1.9 trillion. And, following a seemingly successful experiment in Telangana, three other states have announced a direct cash transfer scheme for rural India, which is likely to cost `300 billion per year. Estimates suggest that if the government were to enact a similar direct cash transfer scheme nationwide, it could cost around `2 trillion. However, if it subsumes some pre-existing schemes, the additional burden will be lower than `2 trillion. The government has increased the issuance of bank recapitalisation bonds from `0.8 trillion in FY18 to `1.06 trillion in FY19. Recall that these bonds were first announced in 2017 to recapitalise India’s public sector banks. Higher MSPs and a new healthcare scheme are other expenses, though of a relatively smaller quantum. After factoring in this additional expenditure burden, the 60% debt target will be difficult to meet, even if the government is successful in doubling its efforts of fiscal consolidation.
So is it all doom and gloom? Not necessarily. Perhaps GST revenues can fit that bill? At present, GST revenues account for a third of the Central government’s tax revenues. Assuming that: (a) this proportion will remain unchanged over the next few years, and (b) that, over that time, the GST reaches a steady state where the Centre’s GST equals the states’ GST, GST revenues will have to grow higher than nominal GDP growth for the next six years to meet the 60% debt target while still being able to fund additional expenditures. GST collections will need to rise from `0.9 trillion today to `2.2 billion by FY25, implying a CAGR of 14.2% for 2019-25.
A debate on whether RBI is over-capitalised has been raging for the last few months. This debate is important because it has implications for how much funds RBI can potentially transfer to the government in the current election year and over the medium-term. If, indeed, some excess capital is identified, these are several ways in which it could be transferred to the government over the next few years, with the following implications. One, instead of using some of the current year’s surplus to add to the contingency fund, RBI can instead be asked to transfer all of it to the government. Two, RBI may be asked to consider making several accounting changes by which it accounts for a larger proportion of its revaluation gains as profit for the year, and shares it as a dividend with the government. Note that, as per the current practice, it does not account for unrealised revaluation gains as profit.
While these would increase the RBI’s pay-out to the government in some years, it does not guarantee a fixed, steady stream of revenues because: (a) RBI’s profit/surplus depends on many other factors, for instance the interest rate environment, and (b) the value of the `. While a depreciation in the ` can lead to higher revaluation gains, the opposite is also possible in any given year. This method of transferring ‘excess’ capital can also have an impact on incentives. It may incentivise the authorities to pursue policies that weaken the `, as that would generate higher revaluation gains. Some pre-existing excess capital in RBI’s balance sheet can be transferred as government revenues over one or a couple of years. If higher transfers and thereby higher government spending stokes inflation, however, leading to tighter monetary policy by RBI, it could impose a cost on private enterprise. If the transfer is made by contracting the RBI’s balance sheet though (for example, selling government bonds), it could impinge on future interest income from these assets that RBI shares with the government. Excess capital in RBI’s balance sheet can, instead, be transferred to the government for writing off government debt. In an economic sense, this is likely to be superior to the previous option because it will not have an inflationary consequence as it does not become a part of RBI’s revenue. However, caution that this write-off of India’s public debt should not interfere with the definition of debt used by the new FRBM committee. All told, while some of RBI’s excess capital could help, it cannot completely be relied upon for reaching the public debt target of 60%.
There is no agency in the government that looks comprehensively at both Central and state, fiscal costs and revenues, and relating them to the fiscal rules that the country has enacted. Without such counsel, the government risks sub-optimal policy decisions. The FRBM committee report of 2017 had called for such an institution, naming it the ‘Fiscal Council’. The idea of the ‘Fiscal Council’ is to create an institution that provides clear analytical inputs and works with the government to deliver better fiscal outcomes, which are necessary for a healthy bond market and higher and sustainable economic growth.
It is time this is set up.
Edited excerpts from HSBC’s India: The fog of fiscal finances (January 10)
Co-authored by Aayushi Chaudhary, economist at HSBC Securities and