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

The Economic Times - - Breaking Ideas - Aurodeep

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

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