While, presenting the budget for 2015-16, finance minister, Arun Jaitely had taken a conscious decision to deviate from the fiscal consolidation road-map drawn by his predecessor and reiterated by him in budget for 2014-15. Accordingly, he fixed the fiscal deficit target as 3.9% of GDP as against 3.6% as per the road-map.
The rationale behind this decision was to give a big boost to public investment in infrastructure viz., roads, highways, rails, power, port, airport etc in the backdrop of sluggish investment by the private sector [groaning under heavy debt and low margins]. The idea was to resurrect growth and push it in to double digit orbit.
For 2016-17, in view of industry clamoring for continued boost in public spending and similar stance taken by some economists within the establishment, an impression was gaining ground that the government won’t mind another round of slippage. But, the strategy has drawn a flak from the RBI governor.
Delivering the CD Deshmukh memorial lecture at National Council of Applied Economic Research [NCAER], Raghuram Rajan did some plain talking. He not only expressed his discomfiture over 2015-16 budget decision [lamenting that even the relaxed target of 3.9% is not within reach], but also took strong objection to the very idea of not adhering to fiscal discipline for the second year in a row.
In today’s turbulent world when major economies are either flat or slipping to entrenched slowdown, if India stands out with high growth rate and inflation under control, it is primarily because of our ‘strong macro-economic fundamentals and in particular, fiscal discipline’. Now, if we compromise, this will affect our credibility and will not be in India’s long-term interest, Rajan argued.
The combined fiscal deficit of Union government and states is 7.2% of GDP. Already, this is higher than the global norm and will further increase due to UDAY [Ujwal Discom Assurance Yojna] [under it state governments will take over 75% debt of state electricity boards (SEBs)] and implementation of seventeenth Pay Commission recommendations etc. In this backdrop, Rajan fears any further slippages will shatter confidence in India story.
He is also not enthused by the idea of increase in borrowings to fund public investment. According to him, the resultant loss [rating downgrade and higher interest cost] will far outweigh the benefits to the economy from higher spend on public projects. Stating that RBI and government have succeeded in their joint efforts to combat inflation, he cautioned against any mis-step [read dilution of fiscal deficit target] that would undermine these.
There can be no disagreement with the need for pursuing fiscal consolidation. An ideal scenario would be one where this is achieved in conjunction with growth. With plunging oil prices, there is substantial saving in subsidy and indirect taxes are also up though shortfall in divestment proceeds has been a spoiler. Jaitely is trying to make up for the latter through other means such as compulsory dividend from central public sector undertakings [CPSUs], though its advisability is debatable.
With low oil price scenario expected to continue for 2-3 years, the government can look for more savings in subsidy. The introduction of direct benefit transfer [DBT] in kerosene from April, 2016 can generate additional savings through better targeting and elimination of leakages. Besides, the three rounds of hike in excise duty on diesel and petrol since November, 2015 will help in garnering an additional Rs 70,000 crores next year.
In fertilizers, thanks to re-negotiation of long-term agreement for supply of gas from RasGas [Qatar], during 2016-17, India will get the full benefit of decline in gas price which was not available during current year. On the assumption that international gas price in spot market continue at current level of about US$ 6 per million British thermal unit [Btu], this will yield saving of about Rs 18,000 crores. If price goes down further, it would be even higher.
In view of above, the government would be reasonable confident of achieving 3.6% fiscal deficit for 2016-17. Now, what is wrong if it were to deviate [a bit] because a step up in public investment is needed for achieving the desired growth? Rajan would say ‘no’ as according to him, this will tantamount to denting India’s credibility as a country that is not serious about fiscal discipline.
Such an approach is ‘myopic’. At a time when, government has fired all cylinders towards fiscal prudence [rationalizing subsidies, eliminating leakages, restructuring welfare schemes with focus on productive use of funds, avoiding profligacy in all governance structures, expanding tax base and reducing exemptions etc], to view some slippage in deficit target as an act of eroding confidence in the consolidation road-map is anomalous.
Additional borrowing by government would have been risky if only it had the effect of crowding out private sector. But, in the present situation when, the private sector is unwilling to invest and its demand for funds from banking sector is mute, such a possibility is ruled out. The risk of this exacerbating inflation is also minimal. Far from that, increase in public investment [even if funded by borrowing] will help in easing inflation.
This is because the money will be flowing to areas which de-congest supply chains. For instance, investment in roads and highways will help improve faster movement of goods thereby easing supply bottlenecks. Increase in availability of cheap power will enable better utilization of capacity and reduce cost. Investment in irrigation will help farmers increase crop yield and boost supplies. Likewise, modernization and augmentation of capacity at ports and railways will have positive spin-offs.
Moreover, increase in public investment at this juncture will have a multiplier effect generating better returns. By giving an all round boost to economic activity, this will also help in resurrecting a host of projects rendered unviable during years of slump. In turn, this would reduce non-performing assets [NPAs] of banks, enhancing their capital base and need for budgetary support. They will be able to lend more giving further push to economy.
With GDP moving on to a high growth path possibly in to double digit, introduction of GST [hopefully, the constitution amendment bill in this regard will be passed in the budget session of Parliament] and cleaning up of tax administration, we will have buoyancy in tax collections. Together with rationalization and pruning of subsidies, the government would have laid the foundation for sustainable fiscal deficit in the long-run.
The world is taking note of these positive developments and that is why rating agencies have no intent of revising their grade even with some deviation in fiscal target. Therefore, the governor needs to shed his over-cautious approach and help Modi seize the moment of putting Indian economy on high growth with price stability.