The price of fiscal exuberance

nitish-kumar

Politics is heating up. Elections in Bihar loom in November with Assam, Kerala, Tamil Nadu* and West Bengal tightly packed together in May next year, just after the FY 2021-22 budget.

Bihar remains rural at heart. Luckily for the BJP, agriculture is the bright star in the Indian economy with expected growth of 3%. Doesn’t look so good? Compare it then with the likely economic contraction this year of between 5 to 15%.

Live COVID, the economic slump has to be ridden through with gritted teeth

There is little the government can do to avoid this slump. For starters, it hasn’t happened suddenly. Growth has been trending downwards since 2018-19.

The global economy is in disarray due to COVID. Nor do the geopolitical headwinds augur well. If anything, retreating globalization and rising protectionist walls will constrain the poorer economies.

Ironically, China is, yet again, likely to be the “Yellow Knight” rescuing global growth in FY 2021-22. The “noise” about luring foreign investment leaving China to India, seems a distraction not a real business opportunity.

A White Paper can force government to abandon generic headlines and tussle with real life policy options

India needs to find its own path out of recession. It is still early days. But putting out a White Paper may be a good idea, telling us how to deal with the impossible trinity of – (1) demand starved industrial recession, related job losses (2) how to reform a flailing, publicly owned financial sector- racked by scandal, fat and inadequate oversight by RBI and the government and finally (3) a blue print for reforming governance which remains trapped in processes completely out of sync with the aspirations of high, shared economic growth and deep social reform.

One Nation One Ration Card is a great example of national aspirations for social protection of the poor. Similarly, GST flags the power of an integrated market. We need more such real world, physical reminders of “India Unlimited”, best illustrated by universal financial inclusion and “portable” mobile numbers for India’s 1 billion adult phone customers.

One step below the high-level concepts identified previously, lie operational concerns on which the government’s strategy remains unclear.

Are we committed to become competitive above all else?

First, is the strategy to make India more competitive and productive. Are we still committed to keeping import tariffs low because they automatically trim the fat-off domestic producers and keep inflation low? Is a “strong INR” going to remain our branding strategy or do we recognize that only a “competitive” exchange rate can facilitate exports and provide protection to domestic manufacturers?

Self reliance yes- but at what cost?

Second, how will government regulate the inevitable premium for “self-reliance”- which translates into higher prices on locally manufactured goods of poorer quality versus “global interdependence” which reduces the cost of goods and services for customers but exposes us to the risk of global disruptions?

Incidentally, periods of high economic growth coincide with high export growth. But global trade is trending down to lower than the global economic growth rate. We need new geopolitical relationships with large overseas markets to grow our exports and suppliers of critical minerals, goods, technology and capital to keep us networked with the growth economy.

Walling ourselves off from the fastest growing, soon-to-be the largest economy – China just plain short sighted or savvy?

Walling off China from India – putting ill-defined Chinese investment through a regulatory filter is one example- and putting all one’s eggs in the US basket is risky. Why be tied to backward looking wish fulfillment rather than buy into the future – a globally dominant China?

Can India do a bigger fiscal splurge than it has?

helicopter

Cut now to India’s latest serial distraction – the “Dance of the seven veils” which revealed the COVID “fiscal stimulus” over five episodes this month – two more veils might yet be lifted. If you belong to the camp which feels it was just “More ado about nothing” consider that it is impossible to stimulate an economy which has never got off steroids.

History not on our side

During the 2008-09 global financial crisis, fiscal deficit (FD) in the three years prior was at 4.3%, 3.6% and 2.8%. Consequently, the higher fiscal deficits of 6.4% (2008-09) and 6.7% (2009-10) provided a fiscal boost of 6.5 % of GDP over two years.

Simulating this boost today would add Rs 7 trillion over and above the Rs 8 trillion already budgeted for, taking the total to Rs 15 trillion. This would increase the FD to between 8% (if GDP falls by 5%) or 9% (if GDP is lower by 15%). Both estimates portend an unstable future because we know that targeting productive investments is tough and pulling out of failed investments even tougher.

Leaving the fiscal tap wide open for too long- an Indian trait?

Consider the 2009-10 fiscal splurge. The fiscal tap remained open all the way till 2013-14 with FD stubbornly high at 4.5% versus the target of 3%.

Lower oil prices thereafter and the BJP government adopting FD reduction as a key performance metric brought the FD down to 3.4% in 2018-19. But economic stagnation spurred an increase to an estimated 3.8% in 2019-20. The “real” FD was higher at above 5% due to unrecognized liabilities like delayed tax refunds, unpaid bills and off-budget proxy expenditure by state owned enterprises.

These liabilities need to be discharged if they are not to clog up the finances of the concerned firms. Consider that MSMEs are owned Rs 4.5 trillion which the FM promised would be paid up by July 5, 2020. There is a liberal-left led outcry against the stingy fiscal splurge. Indian Express May 24, 2020. P. Chidambaram, best known as the Congress party’s reformist Finance Minister, suggests injecting Rs 20 trillion as stimulus. He is surely playing to Prime Ministers Modi’s penchant for round, large targets – a $5 trillion economy or Rs 100 trillion investment in infrastructure are examples.

Finance Ministry not impressed by ex-Finance Minister’s Eldorado – never before fiscal exuberance

It is unlikely to find any salience with the doughty bureaucrats in the Finance Ministry. They have instead, passed the baton to the state governments by relaxing their FD limits from 3% to 5% of GDP. That makes available an additional Rs 4 trillion of borrowing.

The Union government has already set an enhanced borrowing target of Rs 12 trillion this year – 50% higher than the budgeted Rs 8 trillion resulting in a high Union FD between 6.2 to 6.9% of GDP depending on whether the GDP falls by 5 or 15%. With states borrowing 5% of GDP the total FD would be 11.5% of GDP versus the budgeted 6% – not to be sneezed at – no pun intended.

Big is not always the best

More significant than the size of one’s wallet is how this gargantuan volume of public money will be used. Much will depend upon the policy stances that government adopts on global integration, domestic competitiveness, governance reform in labor regulations, limiting sops for uncompetitive firms and sweeping away the cobwebs from the financial sector.

Prime Minister Modi and master strategist, Home Minister Shah still have four years till the next general elections. They should devote this fiscal and the next to deep reform. After all, Bihar might not go to the polls if community spread of COVID remains endemic. Either way, keeping Bihar in hand at the cost of continued fiscal instability, low growth and poor competitiveness seems too high a price to pay.

OOPs! – *The earlier version had wrongly mentioned Telangana instead of Tamil Nadu. The error is deeply regretted.

Also available at TOI Blogs May 25, 2020 https://timesofindia.indiatimes.com/blogs/opinion-india/the-price-of-fiscal-exuberance/

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