Next year’s Budget will reflect many difficulties sprung by the coronavirus pandemic and many countries’ currency-printing spree to keep employment high
The finance ministry and the Reserve Bank of India (RBI) have been grappling with a host of problems created by the virus that China exported. Often, the solutions to these have pulled in opposite directions. Next year’s Budget will reflect all these difficulties in full. So it is time to step back and make it with a framework in mind.
A major problem next year is global monetary irresponsibility, manifesting itself in a huge increase in the supply of dollars, euros, yens and yuans. The suppliers of these currencies account for 75 per cent of global output. This irresponsibility could lead to both predictable and unpredictable problems. We have seen this happen in the past.
Simply put, in order to keep employment high, America, Europe, Japan and China have decided to spend whatever it takes, never mind that they don’t have the money. They are simply printing off the notes to keep their economies from crashing as India’s did this year. India resisted the temptation, largely because of the situation in Ladakh.
This practice of printing notes and spending has been dignified by a respectable name: Modern Monetary Theory (MMT). It was first propounded around 2010 to legitimise Barack Obama’s excessively loose money policy. Don’t worry if inflation happens, the theory goes on to say. Just tax away the extra money to suck it out of the system.
Expedient and dangerous
The theory has been rejected by sensible economists because it asks governments to break the link between their revenues and expenditure. Why? Because countries have a monopoly on the production of currency!
Nevertheless, governments have embraced it because in the short term it is politically expedient and the dangers are all in the long term. But there is a short-term problem as well that the theory doesn’t acknowledge: it believes that taxing away the extra money will be as easy as printing notes.
It further assumes that, even if such enormous taxation happens, the money will just vanish into thin air instead of ending up as a massive government revenue surplus, sitting quietly in banks.
The theory is then completely silent as to what banks will do with all that money. Even if governments impound it by some instrument resembling our own cash reserve ratio (CRR), the money will still be there. Indeed, short of burning the extra currency or demonetisation and simultaneously undertaking massive reductions in bank balances of everyone, there really is no other way out.
India will not remain immune to this massive tidal wave of money. It didn’t during 2001-04 and 2010-13. And it won’t now. The main pressure will come, as it did in those two episodes, via the rupee-dollar exchange rate. The rupee will start to move in ways that the RBI will neither be able to predict, nor control.
During 2001-04, for example, the rupee appreciated by almost 5 per cent. During 2010-14, however, it depreciated by 26 per cent. So how it will behave in the next few years is anyone’s guess.
One reason for the opposite movements was the fiscal deficit. The National Democratic Alliance (NDA) kept it low, around 5 per cent, while the United Progressive Alliance (UPA) let it rip to more than 8 per cent. The Modi government has so far maintained the NDA tradition. But it is under pressure to adopt the MMT. As Mr Modi seeks to revive growth, he may well be tempted to do that.
This financial year will see the revenue deficit – which is really the only thing that truly matters – probably double over the Budget estimate. If it comes lower, it will only because it is well hidden.
The big unanswered question, therefore, is how Mr Modi will handle the revenue deficit without raising income tax. Indeed, he needs to reduce personal income tax. The rest, having been taken care of for the moment at least, or being in the realm of targets, is not important for immediate budget policy.