Fiscal doves in India: Right and wrong
He who knows only his own side of the case knows little of that—john Stuart Mill, 1860
Fiscal doves are absolutely right in emphasising on more money in the hands of the poor in the last one year. They are right that the public debt at even 90 per cent of gross domestic product (GDP) in India is still significantly less than that in many developed countries. Fiscal doves are also right that the cap on the ratio of public debt-to-gdp needs to be revised upward, if interest rates are low. And, they are not wrong in saying that higher public spending is unlikely to be inflationary at a time like this. It is also true that if the private sector is a net saver, then it helps if the Government of India (GOI) dissaves for the purpose of maintaining aggregate demand for goods in the economy. What then is the issue? To take care of the less welloff, there can be an immediate need for bridge financing but an additional fiscal deficit for long is not necessary. The less well-off can be helped through a re-allocative fiscal policy — reducing expenditure on some schemes and increasing it on others (like MGNREGA). We can also use redistributive fiscal policy — imposing a wealth tax and/or inheritance tax on the affluent with a very low marginal propensity to spend, and giving money to the less advantaged who are very likely to spend on consumption. All this was often on the agenda before the 1930s after which the fiscal deficits became (a bit too) respectable.
It is true that if the private sector saves more than it invests, the government can help by borrowing and spending so that the aggregate demand for goods and services is maintained in the economy. However, the GOI can do better!
There is a need to think afresh. In what may seem a digression, the public authorities can change the portfolio of their assets. They can cut down on surplus public land, excessive foreign exchange reserves, and inefficient public sector undertakings while achieving social objectives through better means. These existing public assets can be acquired by savers, given that the savings are more than investment in the private sector. And, the government can get the newly created assets, if the funds obtained from sales of existing public assets are used for new investment! The beauty is that, in the process, the aggregate demand for goods is maintained —without incurring an additional fiscal deficit and without any net selling of the family silver. Using this route is particularly attractive now because asset prices are favourable currently.
Though there is hardly any inflationary pressure and the effect on the aggregate demand is the same whether the public spending is on consumption or investment, the growth of GDP can be higher with investment. And, we do need reasonable growth. It is growth of GDP that is an important factor for the revival of adequate private investment and aggregate demand more generally. This obviates the need for stimulus year after year.
Why consider all this when the government can simply borrow more, given that the debt-to-gdp ratio in India is still less than in, say, the US? The debtgdp ratio is an inappropriate measure for comparison. Here, following the well-known 2010 book, This Time is Different, a measure that is more meaningful than the debt-gdp ratio is the debt-tax ratio. The latter is much higher, and not lower, in India than in the US. And, that is worrisome. This may be, inter alia, bothering several different agencies that give low ratings for sovereign debt in India.
It is true that the rate of interest on government bonds is less than the rate of growth of taxes (and also GDP). This may suggest that the condition for sustainable public debt is met. However, there are two issues here. First, we need to be also sure that the primary deficits will be kept in check in the future years. Second, the interest rate on government bonds is and has been artificially low due to the statutory liquidity ratio “regulation” on banks, which provides a captive market for government bonds. However, this is financial repression, which is socially costly. But what is the alternative?
As seen already, the GOI can use re-allocative fiscal policy, re-distributive fiscal policy, and the policy to move from its existing assets to assets that are a result of higher public spending on investment. These steps obviate the need to substantially increase the public debt. Note that 52.4 per cent of the central taxes in India in FY22 are likely to be spent on interest payments alone!