The government is already in election mode, a time when analysts expect giveaways. But, these constrain public capex. It is a difficult time to rein in revenue expenditure; it just doesn’t work. But if one expects rainy days to arrive soon, the least one can do is prepare for them. Elections are a good eight months away, but the clouds are thickening fast. Macroeconomic headwinds are gaining momentum as murky external developments become unpredictable. The rupee and yields are already under pressure; fiscal restraint is the need of the hour!
With external vulnerability at the edge, policy levers need to be realigned, sharpened and kept ready. While monetary policy can still respond in the short-term, it is fiscal policy that is the major lever available to restore macroeconomic balance. To find additional space in these changed circumstances, policymakers must now rework a tighter fiscal consolidation path. It is well known that the medium-term fiscal consolidation path that the Kelkar panel outlined did not materialise as planned—deficit targets were deferred in two of the past four years as the government opted to scale-up capital spending to offset the private investment shortfall. It also aimed to reorient the spending mix towards better quality expenditure by switching expenditures from current to capital. Hence, subsidy reductions over time were to release space for sustained, productive capital expenditure without overstepping committed deficits.
But, the reality is that, besides postponing fiscal targets, the expected expenditure switch to improve spending quality did not materialise to a large extent. Public capex share of GDP has actually declined, and current spending shares have risen. This is primarily due to food subsidy payments, even as fuel and fertiliser subsidies stabilised after decreasing (thanks to lower oil prices). For now, interest payments are stable too, but one can’t be sanguine about the interest burden in a rising yields scenario. The medium-term fiscal roadmap now has a debt anchor with the fiscal deficit as the operational target. This follows recommendations of the NK Singh headed FRBM Review Committee (RC hereon) which outlined a new debt and fiscal framework last year. The government accepted the roadmap—reduction of central government debt to 40% of GDP by FY23, general government debt to 60% of GDP, and fiscal deficit-GDP ratio of 3.0% of GDP in FY18 to FY20. But the government has once again postponed these targets by two years to FY25 and FY21 respectively.
A more serious issue is that the RC’s initial debt assumption (49.4% of GDP, BE FY17) for computing its roadmap is already overturned as the actual central government debt in FY17 reached 50.3% of GDP! Fiscal deficit assumptions underlying the RC’s debt dynamics to achieve 40% debt-GDP ratio by FY23—3.5% (FY17) and 3.0% in FY18 to FY20 – are overshot too. Much rests on its other assumptions—nominal GDP growth and interest rate at 11.5% and 7.3% respectively. Debt-GDP ratio for FY18 is currently estimated at 50.1%, and is projected to decline to 48.8% this year but actual outturns remain to be seen. A worsened fiscal position of states further compounds the deterioration in the country’s fiscal profile—general government debt/GDP is once again rising from 66.7% (FY15) to 68.6% (FY16) and 68.9% and 70.4% in FY17 and FY18, respectively (IMF Staff Report, 18/254, August 2018). Thus, the RC’s projections are already toppled while delayed implementation makes it very clear that the 40% and 60% debt anchor targets will not materialise as visualised.
This debt build-up can be dangerous when external vulnerability risks have risen. Investors get jittery at such deviations as governments lose credibility, a feature the RC underlines, citing India’s 1991 and 2013 experiences. Sustaining growth is another critical argument as to why fiscal consolidation plans need re-examining: The RC flags that debt dynamics are primarily growth-driven; in addition, there is a genuine need to maintain public capex as private investment is not reviving. So, if growth lets down, all else does too. The changed macroeconomic context therefore demands relooking the planned fiscal consolidation. This holds regardless of how external adjustments come about—through the currency, administrative controls, emergency financing arrangements or even a short-term interest rate response. In the medium-term, the realignment has to come from the fiscal side.
What can the government do? Where can it cut spending and which spending? There is but one point—food subsidy—to accelerate consolidation and release space. Fiscal costs of this have steadily risen from FY08, save a 30bps decline to 0.7% of GDP in FY17; shares have again been rising to match pre-2014 levels. Food subsidy allocations reached 0.9% of GDP (Rs 1.69 trillion) in FY19 but this does not include the additional expense of the promised increase in MSPs. Moreover, accumulated subsidy payment dues to FCI have mounted—Financial Express estimates dues to shoot up to a humongous Rs 2 trillion in FY19 from Rs 1.35 trillion in FY 18!
Then, the interest burden is likely to intensify from rising yields, which makes it imminent to prune food subsidy expenses. Higher fiscal pressures—public debt is already close to thresholds that raise the probability of debt distress amongst emerging market economies according to IMF (Country Report, August 2018)—will compound the external sector stress. There is only so much that monetary policy can do. It is time then to return to the drawing board and reconsider fiscal consolidation, one that incorporates external vulnerability risks. When the NDA government came in May 2014, many analysts hoped it would dilute the National Food Security Act, 2013 along with the Right to Fair Compensation and Transparency in Land Acquisition and Rehabilitation and Resettlement Act, 2013, both passed by the previous government. But, after failing to amend the latter, even the NFSA was rolled out across the country without any meaningful changes, with the cover that subsidy outgo would be minimised with implementation through direct benefit transfer (DBT) scheme. Against this backdrop, an illustrative roadmap to prune food subsidy is explored here. The government can consider three possible actions, or some combinations of these
* Reduce number of beneficiaries—not a big ask if job creation is as robust as claimed;
* Reduce quantities supplied (rice & wheat) under the food security program; and/or
* Raise the issue/subsidised prices.
The roadmap visualises a 20bps reduction in the first two years starting FY20, followed by 10bps annual reductions thereafter to reach 0.3% of GDP in FY23. This assumes a 7.5% real GDP growth throughout with inflation rates at 5% and 4.5% in the first two years, and 4% thereafter. Laying out a roadmap to downsize current expenses such as food subsidies should be the top priority for the new government in May 2019. It will go a long way in alleviating internal vulnerabilities, i.e. fiscal risks, will send the right message to stakeholders and release fiscal space for productive spending to raise output potential. This is the only way to go. A policy discourse and action on these lines is the need of the hour.