BackIs fiscal consolidation off the table in the budget?
What happened to the govt's promise of minimum govt? Why not cut the flab in govt departments and why not go in for privatization?
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Is the government trying to do a U-turn on fiscal consolidation? There are some pointers in the finance ministry’s mid-year economic analysis report. The note states explicitly that “consideration should be given to address the neglect of public investment in the recent past and also review medium-term fiscal policy to find the fiscal space for it".
Elsewhere, while discussing a Macroeconomic Vulnerability Index comprising the sum of the inflation rate, the current account deficit (CAD) and the fiscal deficit, the report says: “The value of the index currently is well above 15 (recognizing that a value below 12—say 4% inflation, 2% CAD, and 6% fiscal deficit—is perhaps safer macroeconomic territory)." The 6% fiscal deficit mentioned here may be just an example, but the notion that it is safer macroeconomic territory is worrying.
At the same time, the government says it will keep the fiscal deficit at the targeted 4.1% of gross domestic product this year. That suggests it wants to change the medium-term deficit targets of 3.6% for 2015-16 and 3% for 2016-17. The groundwork is being prepared for a higher fiscal deficit in the next budget.
What would Reserve Bank of India (RBI) governor Raghuram Rajan think of all this? This is what he said in his last monetary policy statement: “If the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year." Recall that the Urjit Patel committee had said that the fiscal deficit should be lowered to 3% by 2016-17. If the government deviates from that path, will RBI defer a decision to lower interest rates?
The government’s mid-year review also says monetary policy is too tight. So the government seems to want both a fiscal and a monetary stimulus. The differences between the government and RBI on monetary policy are well known, and a higher fiscal deficit in future will aggravate those differences.
The government’s argument is not new. The political left, as well as the Keynesians, have always had a problem with what they call fiscal fundamentalism. They argue that government spending is needed to counter the slump, and the resulting higher growth would lead to more taxes and therefore a lower deficit in future. Everybody agrees the government needs to spend on infrastructure and remove supply-side bottlenecks.
The government’s new insight is the private sector is neck deep in debt, and the banks are too mired in bad loans to be able to support growth, and the government therefore needs to step in and spend. The public-private-partnership (PPP) model too hasn’t worked. Fiscal policy, the mid-year review says, has to be counter-cyclical and counter-structural.
But, India is still an outlier as far as the fiscal deficit is concerned (see chart). Counter-cyclical fiscal policy is all very well, but it should start from a much lower threshold. The critical question is whether a fiscal push now will raise inflation. Those in favour of loosening the purse strings point to excess capacity in many industries and say that prices will not rise. They say the government is talking of increasing capital expenditure, not consumption.
Nevertheless, even capital expenditure has a consumption component—the wages that are paid on building roads, for example, will increase consumption. Let’s not forget that the Seventh Pay Commission award will likely be implemented from January 2016.
A recent International Monetary Fund (IMF) paper said that inflation above 5.5% is detrimental to growth in India, with the negative effects starting when inflation rises above 3%. And the government knows very well the inefficiencies of government spending, with the mid-year review stating: “A balance may need to be struck with targeted public investments, carefully identified and closely monitored, by public institutions with a modicum of proven capacity for efficiency, and confined to sectors with the greatest positive spillovers."
Is the government walking the talk about increasing government capital expenditure? Overall capital expenditure by the Union government over the April-October period has been 3.4% lower than in the same period last year.
Is there no alternative but to increase the fiscal deficit if we want to increase government investment? Many projects are languishing for a lack of coal or gas or power. What needs to be done in these cases is not spend more but remove the bottlenecks. Surely there is enormous scope for savings in better targeting of notoriously leaky welfare programmes? Why not recast the fertilizer subsidy, which has been shown to be harmful for land productivity? Why doesn’t the government streamline the public distribution system or reform Food Corporation of India?
If companies are paralysed by debt, why not change bankruptcy laws so they can be wound up speedily and their assets redistributed? If the goods and services tax is introduced, won’t it lead to more buoyant taxes, which, together with the savings from lower fuel prices, provide fiscal room to increase capital expenditure? Why not tax rich farmers, if resources are such a problem?
What happened to the government’s promise of minimum government? Why not cut the flab in government departments and why not go in for privatization? Nobody will object if, after doing all this, the extra resources the government gets are spent on infrastructure. But in the absence of these reforms, the worry is that the government will take the easy way out and use the need for public investment as an excuse to increase the fiscal deficit.
We have gone down this slippery slope before.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments and feedback are welcome at capitalaccount@livemint.com
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