Fiscal prudence still matters
Govt will need to spend more, but should credibly commit through institutional reform to future transparency and prudence
There is no question that the Narendra Modiled National Democratic Alliance government has, in its time in power since 2014, been relatively careful about visibly appearing to meet fiscal targets. In other words, it has not overspent grievously. That does not mean that there are no concerns. First, the quality of the expenditure was not up to par, given that it prioritised the public sector at the expense of private investment. Second, the Union government has constantly sought to extend its control and share of revenue at the expense of the states. And, third, I say “appearing to meet fiscal targets” because, of course, there are legitimate questions to be asked about the government’s use, in the past, of off-budget borrowings of one sort or another.
In this unprecedented crisis, in which a pandemic has decimated supply chains, while the lockdown necessary for public health, has caused the entire economy to shudder to a stop, there is no question that the fisc will have to respond in one way or another. The level of the crisis is mind-boggling — 27 per cent unemployment, which implies 122 million Indians are out of work, according to the Centre for Monitoring Indian Economy.
The question is: what can the government learn from its own past achievements and failures in order to ensure any fiscal response works in the medium and long term?
But first, the short term. It is necessary to remember that this is not a regular crisis. It is not a crisis of confidence; it is not a crisis of co-ordination. Those can be solved or at least addressed by regular spending, pump priming, and so on. This is a crisis in which we actually want a proportion of gross domestic output to decline — in other words, we want some activity to not take place in case it spreads the virus. When the Markit Purchasing Managers’ Index (PMI) for India falls to absurdly low levels, that is a sign of success. Remember the PMI judges not intensity of a fall, but consensus of a fall. A low PMI shows that almost all the respondents believe output will fall in the coming month — a sign of the lockdown succeeding, not failing. In other words, short-term measures that are out of the standard counter-cyclical playbook will in fact hurt the economy and the fight against the pandemic. Don’t just spend money. It is not just a waste, but dangerous.
What is needed is a package of policies that allows us to conserve national wealth and national assets — going firms, sunk capital, signed contracts, steady jobs — and so on while also addressing the basic needs of the population. This is not the same as the standard tax-cut-incentives-and-spending nonsense that governments trot out in response to demands from chambers of commerce. I am willing to hope that the delay in the government’s announcements of its plans reflects a deep unwillingness to do exactly what is being demanded of it by various economists who should know better.
However, any such package will still not be cheap. It will cost us money — money that will have to be paid for now by borrowing or by printing money, and will have to be paid for later by either increased tax revenue, inflation, or the sale/lease of public assets. This is the hard truth; India is not the United States or Japan, and cannot run up enormous deficits the way those countries can.
It is here that the government would do well to seek to understand the medium and long-term effects of its fiscal decisions, and incorporate what we have learned from the past years of its tenure.
First, it should not prioritise the public sector. Many will point out that the public sector is easier to order to spend than the private sector, so it will be helpful to revive the economy. But the lesson from the past years is that such public sector expansion, even on capital goods, has limited growth benefits beyond a point. That point is marked by the point at which the government allocates to itself, too many of the nation’s financial savings, leaving too little for the private sector to take risks on investment. Some claim that the deficit does not matter because the priority is to save growth — since the ratio of fiscal deficit to gross domestic product (GDP) is what is relevant, a collapse in the latter is as bad as an uncontrolled expansion in the former. But public spending has shown its effects on GDP growth to be more transitory than many hoped. Thus in the design of whatever fiscal expansion is inevitable, the government must prioritise the revival of private investment-led growth in the medium term.
Second, it must keep the states in mind. A ratings downgrade or a financial crisis of some sort can as easily be provoked by a forced expansion in states’ need to borrow. Thus it should stop depending so much on cesses, ensure that transfers to the states are maintained, and meet all its goods and services tax (GST) compensation and other dues.
Finally, it must be absolutely transparent about its plans. It has been handed an opportunity to come clean about how it is borrowing on and off the balance sheet, and to make solid reforms to the fiscal responsibility framework. A simple dilution of the Fiscal Responsibility and Budget Management Act to allow it to borrow more or print money is exactly the wrong way to go about it — it will increase discomfort about Indian figures, and lead to a shortage of resources for spending and investment in the long run. It needs to strictly maintain the prohibition on the Reserve Bank of India monetising the deficit, for example. Nor will a random claim that these are “special circumstances” calling for “temporary measures” be enough. After all, the world knows, to paraphrase Milton Friedman, that whenever the government says “temporary” it eventually becomes “permanent”.
One way in which it can ensure that it is granted more leeway is by constraining its own future action through institutional reform. In particular, the recent recommendation by a high-powered committee that a national fiscal council be set up should be revisited at this point. There are many years of global experience to be called upon in creating this increasingly common institution to oversee government finances and numbers. It would allow for a clear sense that the days of increasing obscurity about finances are in the past, and allow much more headroom for spending and borrowing than would otherwise be made available.