Be the Ant, Not Grasshopper
GoI should use fiscal stimulus to support growth. But only if it has the discipline to make it time-bound
Acoupleof weeksago,around two dozen people lost their lives while trying to cross an overcrowded archaic overbridge in one of downtown Mumbai’s busiest train stations. Earlier this year, farmers from Tamil Nadu stripped themselves and protested with skulls and dead rats at Delhi’s Jantar Mantar, demanding farm loan waivers and government relief on agrarian distress. Last week, Prime Minister Narendra Modi’s reference to the state of the economy in his speech to company secretaries, suggested that the slide in GDP growth from over 7% to 5.7% does not sit well with him.
Atragedy at Elphinstone Road station, a protest by distressed farmers, and a prime minister worried about economic slowdown are all connected to each other in terms of what we generally expect of the government to do in reaction: to spend more money. Let’s revamp Mumbai’s train infrastructure. Let’s provide loan waivers to poor farmers. Let’s increase government spending to help prop up the economy, as it reels from the twin shocks of demonetisation and GST.
Andnoneof theseresponsesareunreasonable expectations. After all, what else should be the motivation of GoI spending other than alleviating pains that its citizens face and when markets are failing the vulnerable?
However, such a ‘fiscal stimulus’ is adouble-edged sword. GoI essentially has two ways of funding its spending: through taxes, or by issuing new debt. There are, of course, other idiosyncratic ways too, like selling off stakes in public sector companies, or auctioning the odd telecom spectrum or coal mine. But these are one-time windfalls and can hardly be relied on for sustaining expenditure.
Increasing taxes is easier said than done. Be it through increasing the tax rate, or the tax base, if the recent rollercoaster rollout of GST is any indication, it is a tough political dialogue forthegovernmenttomanage.Which inadvertently means that the easiest way to fund extra spending for GoI is to simply borrow some more. Every year in the Budget, the fiscal deficit GoI announces — the excess of expenditure over its self-generated revenues — is the amount of debt that has to be borrowed from the markets.
Better Take Ant-acid
For decades, government after government has relied on this easy bandaid solution to fixing short-term problems. As a result, our fiscal deficits have always tended to be high, and we spend over 90% of it simply on interest payments on past debt. India’s debt-to-GDP ratio is uncomfortably close to 70% of GDP. This has meant battling macroeconomic instability, high inflationary pressures and the paranoid need to repress financial markets and banks to ensure that the cost of borrowing remains capped.
India seriously started thinking of a fiscal discipline framework only in the 2000s. It was decided that the Centre’s fiscal deficit was to reduce to 3% of GDP by 2008-09, and revenue deficit (excess of operational, consumption-related expenditure over revenue income) was to be eliminated. States were similarly asked to consolidate to a fiscal deficit target of 3% of GDP.
For a few years, this contract worked. India was clocking high growth rates, seeing increase in foreign investment and a rapid rise in per-capita incomes. This translated into the Cen- tre and states raking in considerable moolah. Meeting fiscal targets became much easier. In fact, we managed to reduce central fiscal deficit to 3% before the target year of 2008-09.
Two events happened in 2008-09 that brought a swift end to the joyride. One, the global financial crisis struck. Two, there was a general election looming around the corner. The UPA government explained the doubling of the fiscal deficit target to 6% of GDP, and the covert ‘off balance sheet’ borrowing of an additional almost 2% — to counter the global economic slowdown. In truth, the huge farm loan waivers, bloating of government spending schemes and splurge on subsidies was well underway before September 2008, when Lehman Brothers crashed and the dominoes started falling.
The problem wasn’t that India overspent in the year of crisis and election. The problem was that once India’s growth bounced back — and the UPA government got re-elected — the fiscal stimulus was not withdrawn. Instead, the splurge continued. The after-effects of this fiscal mismanagement are felt to date, as successive finance ministers are still struggling to steer the ship back to the 3% fiscal deficit target.
Ideally, the fiscal policy should be flexible enough to adjust to economic downturns. But when growth picks up, governments should be ready to tighten belts and consolidate deficits. While the Indian establishment dutifully tends to do the first, it conveniently shies away from the politically sensitive second. This eventually leads to fiscal slippage, debt escalation and inflation.
When the Grass is Greener
So, in principle, there is no problem with the finance ministry making noises about a ‘fiscal package’ to support growth. But this has to be temporary, and needs to be transparently withdrawn the following year. If growth were to pick up sharply, then, as the Fiscal Responsibility and Budget Management (FRBM) Review Committee advocates, a ‘buoyancy clause’ can be invoked and fiscal deficit be cut over and beyond the target.
It’s the ant and grasshopper story all over again. The ant toils hard and saves food during summer while the grasshopper frolics around. Come winter, the ant survives and the grasshopper dies. GoI should seriously consider fiscal stimulus to support growth. But only if it has the discipline of being the ant.
A fiscal cautionary tale