Today's Editorial

27 March 2018

Planning for surprises

Source: By Bhaskar Dutta: The Telegraph

One of the perennial points of discussion about Indian fiscal policy has been the trade- off between fiscal consolidation and the need to maintain an expansionary fiscal policy in order to stimulate the economy. The pre- budget debate on this issue was particularly heated this year since the economy seemed to be stuck at a modest rate of growth. At the same time, the Reserve Bank of India refused to lower interest rates given its apprehension that this would cause the inflation rate to increase beyond prudent levels.

So, would the finance minister reverse existing trends and announce a higher target rate of fiscal deficit or would he continue the trend of the last few years to gradually lower the fiscal deficit? Very soon into his budget speech, it turned out that events during the current year had already forced his hand. There has already been a major lapse in the performance of the government’ s management of the exchequer in 2017- 18, with the fiscal deficit being 3.5 per cent of the gross domestic product instead of the target level of 3.2 per cent.

In most cases, the government fails to achieve the targeted level of fiscal deficit because of overspending. Sometimes, the overspending is on account of circumstances beyond the control of the government. In India, it is often the case that the finance minister underestimates the amount of expenditure required to support new schemes and hence does not make adequate budgetary provision. This certainly seems to be the case in the new budget so far as the National Health Protection Scheme is concerned. Surprisingly, this year has been quite different.

The deterioration in the fiscal situation has not been due to any abnormal increase in expenditure. In fact, the ratio of total expenditure to GDP at current prices actually fell slightly since the rate of growth in GDP outstripped that of expenditure. And total expenditure has been within the limits set out in the budget for 2017- 18.

Unfortunately, total revenue collection has been very disappointing. Direct tax collections have actually been quite buoyant — the finance minister could not resist the temptation of giving himself a pat on the back for this achievement. Not surprisingly, the introduction of the goods and services tax did cause some disruption. The Central government also had to allocate Rs 60,000 crore of tax revenue in order to compensate states for loss of tax revenue due to implementation of GST. However, this should certainly have been taken into account when the budget was prepared for 2017- 18. The major culprit behind the increase in fiscal deficit is the huge fall in non- tax revenue.

The budgeted estimate of dividend income from the RBI, public sector banks and other financial institutions was put at just over Rs 74,000 crore, with the lion ' s share expected to come from the RBI. However, the RBI slashed its dividend contribution by over 50 per cent. There is some poetic justice in this since one reason for the reduction in RBI income is demonetization — the increased cost of printing new notes has been a major contributory factor in reducing RBI income. The fall in non- tax revenue has increased the fiscal deficit by over Rs 50,000 crore.

Arun Jaitley has set the fiscal deficit target for 2018- 19 at 3.3 per cent of GDP and has also relaxed earlier targets for long term fiscal consolidation. Unfortunately, even the more relaxed target may prove to be too ambitious. The government’s intention to provide the world’s largest health insurance scheme is an important measure. But, the government has not done its homework and no one has any idea how much it will cost. A paltry Rs 2,000 crore has been allocated to the scheme — it might cost five times that amount. The finance minister has also announced a large basket of infrastructure projects that the government intends to carry out during the course of the year. Again, it will come as a surprise if there are no cost overruns. So, unlike the experience in the current year, it is quite likely that actual expenditure will exceed the budget estimate during the next financial year.

On the other hand, the government may have been too optimistic in its revenue estimate. Various taxes on petroleum products provide the government with something of a bonanza. International crude oil prices are rising rapidly. In an election year, it is very unlikely that the government will pass on the increase in international prices fully to consumers. The only option then is for it to slash taxes on petroleum products. The government's estimate of disinvestment proceeds may also go awry if it cannot get appropriate prices for some big ticket items like Air India. Much will depend on whether the stock market remains as healthy as it has been during the past year. Experts seem divided on this issue since the more pessimistic among them feel that most shares are overpriced.

Should the finance minister have made a bolder statement of intent by reverting to the original timeline for fiscal consolidation that required a commitment to bring the fiscal deficit down to 3 per cent of GDP? Jaitley has claimed that the economy is poised to return to a much higher growth path in the coming year. This may well be an accurate evaluation since the capital goods sector seems to have recovered. This is complemented very well by the external economic environment which looks promising with both sides of the Atlantic showing clear signs that their economies are growing steadily. An immediate corollary is that additional help from the government in the form of an expansionary fiscal regime is no longer required. In any case, Indian entrepreneurs cannot hope to get government handouts year after year.

Of course, the entire debate would have been pointless if there was no downside to the government following expansionary policies. However, there can be a serious downside. Just as domestic households need to borrow in order to cover the hole in their budget, the government too has to borrow from the market to cover its excess of expenditure over incomes. Exorbitant market borrowing may well result in the “crowding out" phenomenon in which the private sector finds it difficult to borrow because the bulk of the available credit has been acquired by the public sector. If the" crowding out" effect is strong enough, this may offset the stimulus provided by the expansionary fiscal policy. Moreover, if the economy overheats because of excessive pump- priming, then there may be severe inflationary pressures.

So, there are important reasons to practise fiscal prudence unless domestic demand has been very sluggish and that too for a length of time. This does not seem to be an accurate description of the current situation.



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