Stimulus in a time of rising fiscal deficit
With farm loan waivers and UDAY shutting out the space for an expenditure-side stimulus, tax cuts are the best bet
Till recently, the one bright spot on India’s economic landscape was the Centre’s grip over the fiscal deficit. Often measured as a percentage of GDP, this statistic represents the total borrowing that the Government has to resort to meet its annual expenditure. The 14th Finance Commission has stipulated a limit of 3 per cent separately for the Centre and States — and 6 per cent for the economy as a whole. Judged by this yardstick, because its fiscal deficit has consolidated from 3.9 per cent in FY 15 to 3.5 per cent FY16 and FY17; and was further planned to be reduced to 3.2 per cent in FY 18, the Centre has so far performed creditably.
Certain worrying developments, however, have taken place recently. While the fiscal deficit of the Centre has been declining, that of State governments has tended to slip of control. The deficit — which was as low as 2.4 per cent in FY 09 — touched 3.6 per cent in FY16, breaching the 3-per cent limit after nearly a decade.
This was largely because of Ujwal DISCOM Assurance Yojna (UDAY), a financial and revival package for State-owned electricity distribution companies, to help them out of the financial mess which they were facing. For implementing this scheme, State governments had to borrow money from the market.
Now, on top of this measure come announcements of waiver of farm loans by UP (₹36,000 crore), Maharastra (₹30,000 crore ), Karnataka (₹8,165 crore) and Punjab (₹10,000 crore). As a consequence, fiscal deficits of these States may overtake that of the Centre. But the latter too may be at the beginning of another round of subsidies to woo the electorate or tackle the economic slowdown. If so, it is likely that the Centre’s own deficit may now further increase, having already touched 96 per cent of the budgeted figure at the end of August. The Centre and States together may well end up seriously breaching the limit of 6 per cent under the Fiscal Responsibility and Budget Management (FRBM) Act.
Such a development does not augur well for the country. An unacceptably high fiscal deficit, without any attenuating features, may eventually completely ruin the chances of an upgrade by ratings agencies who have even currently placed India in the lowest investment class of BBB-.
This is just above the junk status. Alternatively, an out of control fiscal deficit might reduce the sovereign credit rating to junk. This is bound to adversely affect the interests of both the Government as well as Indian business, who will find it much more difficult to raise funds abroad and attract investments to India. Domestically too, a high fiscal deficit will crowd out private investment and possibly lead to the return of inflation in the economy.
It is nobody’s case that the Government should not deal with the current slowdown, help the poor or alleviate agrarian distress. The question is whether incurring expenditure through unaffordable subsidies is the only option.
A farm loan waiver is nothing but a poorly targeted subsidy to farmers that transfers liabilities from private books to that of the State. It leaves out about two thirds of small and marginal farmers who had to borrow from private informal channels. It also penalises those farmers who diligently paid their debts. The ₹52,000 crores waiver granted to farmers in 2008 hardly addressed the issue because farmer suicides continued unabated. In the 1980s, the Centre coerced public sector banks to run loan melas. A few years later, The best way to revive economy
because the farmers could not pay their debts, VP Singh’s government announced a debt relief package of ₹10,000 crore; it took public sector banks a decade to recover from that hit.
States should also consider the opportunity cost of this fast spreading contagion. If more States are pressurised to implement similar schemes the total cost to the exchequer, estimates the Economic Survey (FY 17), would be about ₹2.7 lakh crore ( about 1.8 per cent of the current GDP).
The same expenditure on building irrigation facilities, roads, warehouses and other infrastructure would help farmers earn higher incomes on a much more durable basis. Even if a subsidy is required to be given, it would be much more equitable and efficient to distribute it as an outright grant or a universal basic income to all equally placed citizens after taking into account the fiscal space available and after subsuming all other subsidies which the beneficiaries receive from the Government.
The Centre too should reconsider any stimulus package it may currently be considering to deal
with the recent slowdown in the economy, if this enhances its fiscal deficit. An alternative to such a package would be a reduction in the rates of interest, but that would fall within the domain of the RBI, who would be governed by its own parameters while considering such a move.
Make the cut
This would leave only disinvestment and reduction in the rates GST and income-tax within the control of the Government. Both are good ideas, but reduction in rates would be easier to implement. This measure would put more money into the hands of the people.
The economy would as a result benefit from the increase in both private consumption as well as savings. To meet the new demand, firms would bring into use their excess capacities, and ultimately incur the much needed capital expenditure needed to create new capacities for increasing production and generating employment.
Indeed, the recent reduction of GST rates announced by the FM is a step in the right direction, even though the tax itself continues to suffer from multiple rates and complex provisions. Indian fiscal history teaches us one important lesson: contrary to taxpayer behaviour in the developed world, in India, whenever income-tax rates have been reduced, revenues have increased.
This is because people report higher incomes: when Indira Gandhi, for example, decreased the maximum marginal rate of income tax from 97.75 per cent in 1974-75 to 77 per cent in 1975-76 and 66 per cent in 1977-78, personal income- tax revenues grew from ₹362 crores in 1974-75 to ₹480 in 1975-76 and ₹542 crores in 1976-77.
Between 1985-86 to1987-88, VP Singh lowered the maximum tax rate from 67.5 per cent to 50 per cent and brought down the number of slabs to four.
Roughly corresponding to the period of this reform (between 1984-85 and 1988-89) collections increased from ₹697 crores to ₹1492 crores. There is hardly any reason taxpayers should behave differently this time.
The writer is former chief commissioner of income-tax and ombudsman to the income-tax department, Mumbai
Give more to spend