India’s fiscal situation is precarious. But reducing the deficit cannot be the only objective – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/view-indias-fiscal-situation-is-precarious-but-reducing-the-deficit-cannot-be-the-only-objective/articleshow/93195200.cms

Synopsis

The combined deficit of the Centre and the states – which is the relevant parameter – is probably close to 10% of GDP. The debt-to-GDP ratio is almost 90%, compared to our target of 60%. These numbers are much higher than for other countries. Since output has now recovered to pre-pandemic levels, it is time to set new fiscal targets that would signal a return to fiscal rectitude.

Montek Singh Ahluwalia

Montek Singh Ahluwalia

The writer is former deputy chairman, Planning Commission

India’s fiscal situation is clearly very difficult. GoI‘s fiscal deficit target before the pandemic was 3% of GDP for 2020-21. It shot up in the pandemic year, and has declined only slowly since then. It is projected at 6.4% (BE) for 2022-23. Allowing the deficit to increase to deal with the pandemic was definitely the right thing to do, and other countries did the same. However, India had much less ‘fiscal space‘, and is, therefore, in a more difficult situation.

The combined deficit of the Centre and the states – which is the relevant parameter – is probably close to 10% of GDP. The debt-to-GDP ratio is almost 90%, compared to our target of 60%. These numbers are much higher than for other countries. Since output has now recovered to pre-pandemic levels, it is time to set new fiscal targets that would signal a return to fiscal rectitude.

What GoI should do to restore fiscal sustainability.

The first step is to signal the new targets. This calls for a projection of GoI targets for the fiscal deficit, plus the amount of borrowing state governments will be allowed to do. The two together determine the combined fiscal deficit.

The finance ministry used to present projections of the central fiscal deficit for two years beyond the current year. However, the current year’s budget documents only give an estimate of the central government fiscal deficit for 2022-23.

The ministry should even now consider putting out a two-year projection for 2023-24 and 2024-25 indicating how GoI’s fiscal deficit will move. If it also announced the total borrowing that will be allowed to the states in this period, the two together would give an idea of the movement in the combined deficit over the next two years.

We need to reduce the combined fiscal deficit by around 5 percentage points of GDP over the next four years. Within this target, we could fix a reasonable target – say, 3 percentage points of GDP – to be achieved over the next two years. This reduction can be apportioned between the Centre and the states.

Reducing the deficit cannot be the only objective. We also need to increase expenditure in certain key areas if we want to achieve growth that is both inclusive and sustainable. We need to plan for the following increases over the next four years:

2% of GDP on infrastructure, especially climate-related infrastructure.

1% each on health and education.

0.5% to support R&D (including agriculture research to develop seeds to deal with climate change).

0.5% for capital expenditure on defence.

Reducing the fiscal deficit while also increasing desirable expenditure calls for a total fiscal effort that is larger than the deficit reduction. This means we need a combination of an increase in tax revenues as a percent of GDP and some squeezing of unproductive expenditure.

On the view that high fiscal deficits don’t matter for India because GoI doesn’t borrow in foreign currency, so there is no danger of an external crisis of the kind that happens when borrowing is external.

We are, indeed, better off because the government borrowing is mainly domestic. But this does not mean high fiscal deficits do not matter. High deficits financed by domestic borrowing also cause problems, the most obvious one being crowding out of private investment, which jeopardises growth. RBI has projected 7.2% growth for 2022-23. This looks good. But it takes credit for 16% growth in the first quarter, reflecting the depressed base of Q1 2021-22 when the Delta wave was underway. Thereafter, there is a steady decline in subsequent quarters with only 4% growth in the last quarter.

This seems to suggest that RBI expects growth to return to the pre-pandemic level of ‘4%-plus’ a year. This will simply not generate the growth of jobs we need. We need a strong revival of private investment if we want to avoid this outcome, and that calls for creating room so private investment can expand.

Low growth also means that the fiscal situation will deteriorate in terms of the debt-to-GDP ratio. We have to remember that a high growth rate is the best way of ‘growing out’ of the debt problem.

The crowding out problem cannot be resolved simply by encouraging RBI to ‘accommodate the fiscal deficit’. This is a recipe for a loose monetary policy that runs the risk of high inflation and/or a widening of the current account deficit (CAD). Both the inflation scenario and the current account situation don’t warrant taking any risks on those fronts.

To summarise, the situation would be difficult to manage even if the rest of the world were normal. But the global economy is anything but normal. Inflation is occurring at very high levels and this has provoked belated monetary tightening. Everyone expects the global economy and world trade to slow down, and this prospect is only strengthened by the continuing uncertainty about how the Russia-Ukraine crisis will be resolved.

So, are we in a crisis situation?

No. But we need to reassure analysts and investors that our fiscal situation is being corrected and that our growth prospects remain strong. The case for spelling out a credible corrective strategy is all the stronger because global prospects are muddied by uncertainty and possible reversals of capital flows from emerging markets. As an emerging market country, we are potentially vulnerable. Our policymakers would be well advised to publicise the corrective steps they intend to take.

In practice, this boils down to being seen as repairing the fiscal roof before it starts raining really hard, and also pushing reforms that will increase productivity and improve investor sentiment. And action is needed on these fronts by both the Centre and the states.

As far as the Centre is concerned, setting transparent fiscal targets for the next two years is an important step, and it need not wait for the budget. As far as tax revenues are concerned, getting the goods and services tax (GST) reforms that have been much discussed, underway would be an important signal.

The ball is also very much in the states’ court.

Much of the action needed in curbing unproductive expenditure is at the level of states. There is no way the Centre can guarantee that the states will take action. But it can give a lead by showing that it is doing its bit and encouraging the states to follow. States that do the right thing will show better performance, and, hopefully, their experience will encourage others to follow.

The writer is former deputy chairman, Planning Commission. He is author of Backstage: The Story Behind India’s High Growth Years

(As told to ET Edit)

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s