SynopsisThus, it might be prudent to go the extra mile to consolidate debt when the economy is booming. A way to formalise this would be to target an average fiscal deficit ratio over a period, instead of defining a linear glide path.
A senior economist of the government was recently reported to have told a group of industrialists that asset creation, and not fiscal stimulus, was the budget’s aim. This somewhat curious interpretation of what at first glance appears to be textbook fiscal stimulus, reflects a mindset common among our policymakers for many years now. This often compels them to be somewhat apologetic about fiscal expansion, choosing to couch these efforts in less controversial phrases such as ‘asset creation’.
There is reason for this. The history of missed fiscal targets and relatively large public debt has made many economists wary of ‘fiscal dominance’. India had the highest government debt among comparable emerging markets at 72.3% of GDP, compared to China’s 56.5% or Indonesia’s 30.5%, going by the International Monetary Fund’s data for 2019.
GoI’s persistently large borrowings to finance its deficits create problems for private borrowers in the short term who can be ‘crowded out’. Over the longer term, high public debt creates an unavoidable burden that present and future generations need to service. Thus, fiscal stimulus and the inevitable widening of the fiscal gap have been a no-no for them.
The question is whether they should wag their fingers even when there is a crisis — or, indeed, any prolonged dip in the economy. Instead, should countercyclical fiscal policy become part of our policy lexicon to be used judiciously, but unapologetically? The clamour for fiscal stimulus is, incidentally, not a product of the Covid pandemic. It had become progressively louder a good couple of years before it struck. GDP growth declined from 8.3% in 2016-17 to 4% in 2019-20.
A few things need to be understood in this context. The stock response in India to an economic slowdown or crisis is to attempt a new set of reforms. This is welcome. Deep economic pain does give the government the political capital to push through difficult decisions and changes. However, reforms typically work over the medium term and are not a substitute for countercyclical policy that is specifically designed as a short-term response.
Recipe for the Dip
The jury is out on whether there are systematic business cycles in India. There are certainly dips and spurts. But unlike more developed economies, they are certainly less predictable, and their drivers go well beyond the simple dynamics of inventory destocking and restocking that drive a copybook business cycle. The incentive and willingness of the private sector to invest is a key driver of our economic vicissitudes. In this, GoI plays a key role.
Changes in interest rates and ‘automatic stabilisers’ in which proportional tax rates lower the government’s tax-take and boost the economy in the process that work well in the developed world are often inadequate to pull India out of a trough. In fact, if the right lags are used to measure this, government spending appears to boost private investment.
The Economic Survey for 2020-21 recognises this clearly, ‘…for emerging economies such as India, an increase in public expenditure in areas that boost private sector’s propensities to save and invest, may enable private investment rather than crowding it out.’ Its principal author, GoI’s chief economic adviser (CEA), makes a strong pitch for more active fiscal policy management especially in times of crisis. One hopes that his other colleagues at the helm are convinced enough to consider it a more permanent feature of economic policymaking.
This becomes particularly important if one takes a grim view of the future in which crises will become more frequent and often driven by non-economic shocks like Covid. The likelihood of climate change being the next trigger is currently in vogue. The consensus also is that trade protection, anti-immigration policy and other ‘deglobalisation’ trends notwithstanding, the world has become way too flat to prevent rapid transmission of these shocks across the globe.
In this context, we need to ponder over a couple of things. Should expansionary fiscal policy always be necessarily judged by the physical assets it creates? To put it differently, is a cyclical downturn invariably a supply-side problem that would resolve if supply bottlenecks are removed? Instead, shouldn’t its merit be judged on the basis of how quickly it props the economy up? It may then be sensible to assess the efficacy of things like cash transfers or employment guarantees (including an urban job guarantee scheme).
Debt as National Heirloom
Second, is there a risk in all this of giving the business of public debt reduction the short shrift? Are we, as former RBI governor D Subbarao put it, ‘…sinning against our children’ who have to service and repay the debt by playing our fiscal hand? The CEA argues that if debt adequately fuels growth, it could actually lead to consolidation. While his math is elegant and convincing, there could be a few niggles.
Thus, it might be prudent to go the extra mile to consolidate debt when the economy is booming. A way to formalise this would be to target an average fiscal deficit ratio over a period, instead of defining a linear glide path.
There are, alas, no free lunches here, and raising some tax rates during an upswing may be imperative. However, the promise of fiscal stimulus on a downcycle might make this more palatable.
The writer is chief economist, HDFC Bank. Views are personal