The one thing that could aid FMs in this incredibly complex (hopeless?) task and make the job a little less difficult, is rapid economic growth. Growth is the elixir! As companies and people become more prosperous, they are able to pay more taxes, thereby providing government with revenues to spend and do all the things necessary to honour its ‘contract’ with citizens.
The problem is growth is not exogenous, that is, something that happens by itself. Whether in India or elsewhere, it is, invariably, the outcome of deliberate government policies, tools and instruments that support growth. In the Indian context, the Union Budget is one such powerful policy tool. Hence the importance of Budget 2020-21.
On the face of it, the Budget is a statement of the union government’s revenues and expenditures. But it is much more than just a bland accounting statement. Over the years, budget speeches have become a platform for signalling government’s main policy intent for the coming year/s. These could, and often have had a positive impact on sentiment; a prime example being the July 1991 Budget that initiated the reform process.
More importantly, by fixing the fiscal deficit or the excess of government expenditure over its receipts (that government will have to borrow to finance expenditures listed in the budget) the Budget sends a powerful message regarding government’s fiscal policy. A higher fiscal deficit implies an easy fiscal policy, indicating government’s willingness to provide a fiscal stimulus, that is, spend in order to support growth even if it does not have the necessary resources and has to borrow to spend.
The size of the fiscal deficit – both in absolute terms and as a percentage of GDP – is important because it is a key determinant of interest rates in the economy since government borrowing sets the floor for all other interest rates. The reason is simple! When government borrows, there is no question of default (because as the sovereign government alone has the right to print money to repay its debt).
Despite being risk-free, other things remaining the same, the higher the fiscal deficit, the higher the rate of interest government will have to pay on its borrowings, since it has to compete with other borrowers for the pool of public savings. The key to macro-economic stability, therefore, is to keep the fiscal deficit or government borrowing within prudent limits. This in turn, ensures all other interest rates in the economy (derived by adding the risk premium to the interest rate on sovereign borrowing) are not unduly high and corporates are incentivised to invest/people to borrow, all of which keeps the wheels of the economy churning.
That’s in a business-as-usual scenario. Unfortunately, Budget 2020-21 is not being framed in a business-as-usual scenario but against a background of sharply lower growth. First, advance estimates of gross domestic product (GDP) for 2019-20 show economic growth is likely to come in an 11-year low of five percent, with nominal growth coming in at a 42-year low of 7.5%! Juxtapose these numbers against the estimates that formed the basis of revenue and expenditure projections in Budget 2019-20 (nominal growth of 12%) and it is blindingly obvious that there is no way Nirmala Sitharaman can adhere to her promised fiscal deficit target of 3.3% for 2019-20. While revenues are likely to fall vastly short of projections made in Budget 2019-20, expenditures are not likely to be much lower. Not unless government consciously refrains from spending!
Except that this could have disastrous consequences at a time when the private sector is still shy of investing. According to the advance estimates, investment is likely to grow just one percent this fiscal as against 10% last year. In such a scenario, any cut back of government expenditure is likely to hurt growth further.
What does all this mean for the fiscal deficit? It means that even if the fiscal deficit in absolute terms is contained at the targeted level of Rs 7.03 lakh crore, lower nominal growth will push up the fiscal deficit to 3.4% of GDP. Indeed, if we go by the November 2019 FD number of Rs 8.04 lakh crore, fiscal deficit is already within kissing distance of four per cent of GDP. Add some of the fudges (resorted to by all governments) such as deferring expenses to the next financial year, and the actual fiscal deficit might well be in the region of five percent.
So should government take fright at the larger-than-anticipated fiscal deficit and tighten its purse strings? Most emphatically not! It is no exaggeration to say government spending is almost the only driver of growth today. Any attempt to cut back on this in the false belief that we must somehow stick to an arbitrarily-determined number of three per cent for the fiscal deficit will drive the last nail into the economy’s coffin.
Remember, there is no sanctity to the fiscal deficit number of three percent. Remember also, that if the US government had been as timid about exceeding its budget deficit in the aftermath of the global financial crisis in 2008, the US might still be in a recession. Indeed, India’s fiscal deficit shot up to over six percent in the last year of the UPA government and though we are now suffering the consequences of excessive loosening of the fisc in the last years of the UPA, there is no doubt it kept the wheels of the economy running in the aftermath of the global financial crisis.
For all these reasons, and more, now is the time for the FM to take courage in her hands and use the only tool at her command – fiscal easing – to provide the much-needed counter-cyclical stimulus to the economy. The only caveat is that the additional spending must be used for the creation of capital assets, read infrastructure. Rating agencies and multilateral agencies might cry foul. But as FM, Sitharaman’s duty is to the people of the country and deliver growth. Armchair advisers who have nothing at stake must be shown the door. Politely, but firmly!