Fiscal slip up 2 ppt, need to structure package carefully

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Published: May 9, 2020 5:35 AM

A Rs 4 lakh crore extra borrowing acknowledges huge fiscal slippage; raise loan-guarantee component in package.

Under normal circumstances, that is an almost sure trigger for a ratings downgrade, after which a large amount of FPI flows will have to exit India as their mandates require a country to be investment grade.Under normal circumstances, that is an almost sure trigger for a ratings downgrade, after which a large amount of FPI flows will have to exit India as their mandates require a country to be investment grade.

The sharp increase of over Rs 4 lakh crore in the government’s borrowing target—for now—is acknowledgement of the sharp deterioration in its finances. Indeed, tax collections alone could fall short by this amount, and then there are the disinvestment targets that pose a big challenge. So, even without looking at what happens to state government deficits—as a result of their own revenues as well as central devolutions collapsing—and the massive expenditure that will have to be made to deal with containing Covid-19, it is clear the ‘public sector borrowing requirement’ will rise to 12% of GDP or even more. Under normal circumstances, that is an almost sure trigger for a ratings downgrade, after which a large amount of FPI flows will have to exit India as their mandates require a country to be investment grade.

While this is the reason why the government has not come out with a stimulus package so far, not doing anything is no solution either. For one, as the economy collapses—and reviving it gets more difficult once large swathes of industry shut down as they will without government support—and tax collections fall, the economy gets close to getting downgraded anyway as servicing debt becomes that much more difficult. Also, it is not as if doing nothing is costless either. If there is no package and businesses start defaulting on bank loans, apart from the human costs—large direct payments will have to be made to the unemployed—the government will have to bear the costs of recapitalising PSU banks whose loans will turn NPA.

In which case, the government’s rescue package has to be structured in such a way as to give the biggest bang for the buck while, at the same time, assuaging investor/rater fears. Certainly a large component has to comprise guarantees for loans extended by banks/NBFCs; if a large share of this turns bad, as it will, the bill will come due a year or so from now—not this year—if RBI suspends its NPA-recognition norms for a year or so. This alone will not do the trick and large direct infusion of cash—by way of a public sector-led investment programme and money transfers to vulnerable groups—will also be needed.

Ideally, the government should match the massive increase in expenditure—it is unlikely this is the last of the increases in the government borrowing programme—with a structured plan to cut both debt and expenditure. Including LIC, the value of PSU shares with the government are around Rs 15 lakh crore; all of this should be put into a big mutual fund-type structure, and a systematic disinvestment plan should be put in place to sell, say, Rs 10,000 crore of shares on the first of every month irrespective of what the market price is, and that money be used to retire debt. Sweeping reforms should plan to slash wasteful subsidies—two-thirds of Indians get a 90% subsidy on wheat and rice!—or expenditure on inefficient organisations like FCI; for those who think sweeping reforms are difficult, could anyone have imagined the sweeping labour reforms in a few states over the past few days? Addressing investor fears—slash crippling government levies in areas like telecom and oil/minerals—and opening up of new areas like retail-FDI and genuinely removing bureaucratic hurdles to business will pull in large investments to make up for slower local investment levels right now. India has always reformed in a crisis, so something good may just come out of Covid-19.

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