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In a Macroeconomic Bind

C P Chandrasekhar ( teaches at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.

Despite it being the government’s last full budget before the general elections in 2019, the finance minister, constrained by his self-imposed fiscal deficit targets, settled for rhetoric and promises that were not backed with allocations. This frozen macroeconomic policy has foreclosed all options to adopt proactive measures that could make a difference to those who need support. Yet, the financial interests he wants to impress also seem disappointed.

With 2018–19 being the last full fiscal for the Narendra Modi government, Union Budget 2018 was expected to incorporate a big push to woo an electorate that would vote in the parliamentary elections scheduled for 2019. In budgetary terms, a big push would imply action along two interrelated lines.

First, the government should loosen its purse strings and expand expenditures, to infuse an element of buoyancy into the economy, even if at the expense of some inflation. Though international oil prices are on the rise, the current level of inflation is not overly high. With substantial foreign exchange reserves in hand, imports to rein in excessive price increases in specific areas are also easily financed. So this was an option that was open.

Second, the government should use the leeway offered by the increased level of expenditure to direct resources to projects and schemes that are likely to enhance the popularity of the ruling
dispensation and catch the attention of crucial vote banks. As the literature on “political business cycle” shows, such action is not unusual in democracies, and does influence performance in years when governments near the end of their term.

Surprisingly, deviating from this behavioural pattern, Finance Minister Arun Jaitley chose not to opt for a large expenditure hike. The central government’s expenditures (excluding Finance Commission mandated transfers) is projected to rise by just 10% in nominal terms in 2018–19, as compared with the revised estimates for 2017–18. Allow for inflation and the increase is marginal. Combine this with the reticence of a conservative, inflation-targeting central bank to cut rates, and the macroeconomic environment seems to be biased in favour of contraction rather than expansion. The two main macroeconomic arms of the government, the central bank (whose independence the recent experience with demonetisation has shown to be non-existent), and more importantly, the Ministry of Finance, have refused to adopt an expansionary stance. In keeping with that, the Ministry of Finance has consciously chosen to avoid economic manoeuvres that could be interpreted as election aimed and therefore “populist.”

Jaitley’s 2018 budget speech did spend time listing his government’s achievements and promising much in the form of programmes, varying from a much higher minimum support price (MSP) for agricultural products to a health protection scheme that would be “the world’s largest funded health care programme.” Overall, budget speech 2018 was replete with many trivial and some extraordinary promises, with an eye to the electorate. But it did not back them with the resources needed to at least partially convince the citizenry that the government is serious. “Partially” because, even if the budget documents had incorporated expenditure figures that rendered these projects and schemes administratively feasible, there is no guarantee that the government would have actually undertaken these expenditures and implemented the schemes. Whether it did or not only the revised estimates in next year’s budget will reveal. And there is enough evidence from the past that various schemes and projects have withered away because inadequate, little or no resources were actually provided in consecutive budgets to execute them. In the case of budget 2018, however, budgetary figures did not show that the government was serious about its promises.

This does suggest that the finance minister and the Prime Minister, who unfailingly backs him, see themselves being subject to one overriding constraint. They cannot even print numbers that reflect calculations or guesstimates of how much more they need to spend to execute the special, pre-election promises they make. Making promises seems fine, but projecting a rise in spending was unacceptable. Together with a neoconservative monetary policy stance, this adherence to fiscal rectitude has rendered macro­economic policy completely ineffective—a fact merely highlighted by this pre-election budget.

Unable to Walk the Talk

To understand such behaviour, it may be useful to consider a counterfactual. What would have been the implications of recording an increase in spending? Those expenditures would have had to be matched with additional resource mobilisation measures, failing which the fiscal deficit would have had to be much larger.

Finance ministry mandarins have adopted revenue estimates that have assumed extremely high tax buoyancy, so whatever resources could be attributed to that channel have been drawn on. New direct taxes cannot be imposed since successive post-liberalisation governments have convinced direct tax payers that rates would fall and revenue accretion from direct taxes would depend on better compliance. Moreover, as part of its effort at building a business-friendly image the finance minister had already promised to reduce the corporate tax rate from 30% to 25%. Though he has delayed implementing that promise in the absence of enough alternative resources, he has gone part of the way by extending a concession earlier applicable to registered firms with turnover of ₹50 crore or less, to those with a turnover of ₹250 crore or less, which he claims would cost him ₹7,000 crore.

He has partly neutralised that loss by resorting to hikes in indirect taxes (customs duties) aimed at protecting some industries from foreign competition, and imposing an additional across-the-board 1% cess on income and corporate taxes, taking the total from 3% to 4%. Yet, the finance minister has not been able to garner much by way of additional resources. The result is that even after allowing for receipts from disinvestment of ₹80,000 crore (as compared with ₹72,500 crore in budget 2017–18), he has had to accept one more year’s deviation from the fiscal deficit reduction “glidepath” that he had set himself, with the figure set at 3.3% as compared with the slightly enhanced 3.2% that was budgeted for 2017–18.

In sum, if the finance minister had chosen to provide for the spending needed to render decisions like a hiked MSP and a huge healthcare plan feasible, he would have had to show a substantially higher fiscal deficit.

So, fiscal conservatism at all costs has meant that budget 2018 has focused on avoiding any large scale deviation from the Fiscal Responsibility and Budget Management (FRBM) based commitment to fiscal deficit reduction or fiscal consolidation, despite a tight revenue situation. A corollary is that the finance minister has not been able to allocate resources to render his pre-election promises credible.

Moreover, allocations even for pre-existing programmes that are in keeping with the claim that the budget is pro-farmer, for example, has been minimal. Thus, though Part A of the budget speech repeated the words, rural, agriculture and farmer, the allocation for the Department of Agriculture, Cooperation and Farmers’ Welfare has been increased by just 7% in nominal terms in budget 2018–19 as compared to the revised estimate for 2017–18. That would be a negligible increase in real terms. Rather than significantly increasing budgetary support for a sector in crisis, which forced some state governments to accede to demands for farm loan waivers, the finance minister has merely offered more debt to the farmers. He promises to increase the flow of institutional credit to agriculture from ₹10 lakh crore to ₹11 lakh crore. That is not government money, but that of banks that are also reeling under a crisis.

Similarly, the Mahatma Gandhi National Rural Employment Guarantee Scheme, a United Progressive Alliance creation that the National Democratic Alliance was reluctantly forced to accept as a “flagship” programme, is only mentioned in passing in the budget speech. Allocations for the programme for 2018–19 have been kept at the same level of ₹55,000 crore as provided for in the budget for 2017–18. It is another matter that the full amount was not even spent in 2017–18, despite the overwhelming evidence that the demand for jobs under the scheme was large and wages are in arrears. All this suggests that adherence to fiscal consolidation has taken precedence over political considerations.

By all accounts, there is one fear that drives this obsession with fiscal consolidation even in an election year. That is, the perception or belief that any significant deviation from deficit targets would adversely affect investor sentiment and trigger an outflow of capital. Since that would upset stock markets and could weaken the rupee, it is argued, it could set in train processes that would be damaging for the economy.

Interestingly, through much of the 1990s, when India was assiduously, even if not as successfully, wooing foreign investors, deficits were kept at higher than targeted levels, without triggering outflows for that reason. In years when outflows were larger than usual, the explanation lay elsewhere, especially in developments and circumstances outside the country.

There is one difference today, however. In the years since 2004, net inflows into India have been large, resulting in a large accumulation of legacy investments in the country. This “success” does imply that if investor confidence is adversely affected, the magnitude of outflows can be much larger than earlier and the consequences more dire. But such fears too can be exaggerated.

No Clever Accounting

If high levels of the actual deficit figure are to prove damaging, obvious and easily recognised manipulations of the figures of the deficit should also evince adverse responses. An example of such manipulation is the financing of the recapitalisation of public sector banks with resources garnered from “recapitalisation bonds.” In fact, in the past, the government was reticent to allocate too much of its funds for recapitalisation because it would impact adversely on its fiscal consolidation efforts. This time around, however, the government claims that its pre-budget decision to provide ₹1,35,000 crore for recapitalisation through the issue of bonds for the purpose is an ingenious way of providing capital without upsetting fiscal deficit calculations.

But this should fool no one. The idea seems to be to use the excess deposits with the banks to get them to buy the government issued bonds and for the government to use the money to acquire new equity in the banks. The argument is that since there is no net outflow or inflow of money for both government and the banks, and the sums match, nothing is affected. That, however, is not even clever accounting.

To start with, since the fiscal deficit is the excess of government expenditures (revenue and capital) over government revenues, the investment in public sector equity must be included in the deficit. Second, this amount cannot be excluded from the deficit figure on the grounds that it is being funded with “non-debt creating capital receipts,” since debt is being used to finance it. And third, the fact that interest paid on the recapitalisation bonds and dividends received from the equity purchased would feature in future budgets is proof that debt is being used for a capital acquisition. So spurious claims to the contrary aside, the government’s fiscal deficit containment plan is going awry, even if the figures do not feature in the budget.

Frozen Macroeconomic Policy

So it is not the deficit alone that is the problem. The fears of the government must stem from the fact that the type of expenditure that results in a larger deficit is what bothers finance capital. So-called “populist” expenditures that provide minimal employment to the poor (such as the Mahatma Gandhi National Rural Employment Guarantee Scheme) or a minimal level of social protection for the poorest (such as the proposed national health scheme) are unacceptable. But money spent to ensure stability in the financial sector, however temporarily, is fine. The issue is not the deficit. It is that the government should not be seen as favouring those in the lower income groups as opposed to favouring capital.

This has pushed Jaitley into holding for those schemes and programmes that should win it popular support. The effectiveness of those promises in garnering social support, if significant at all, is considerably diluted. But Jaitley’s problems extend further. With revenue growth turning sluggish because of the light touch taxation characteristic of the liberalisation years, and the promise of higher revenues from better compliance and innovations such as the goods and services tax remaining unrealised, money to sustain even routine expenditures is difficult to come by.

The problem has been partly resolved in 2017–18 through disinvestment and strategic sale, receipts from which being “non-debt creating” are excluded from the fiscal deficit. But that too has been pushed to the extreme through measures such as the sale of public sector equity to other public sector firms (Hindustan Petroleum Corporation Limited to Oil and Natural Gas Corporation or ONGC), as a result of which in fiscal 2017–18, disinvestment receipts are placed at ₹1,00,000 crore, as compared with a budgeted ₹72,500 crore. What was surprising is that despite such measures, the deficit in 2017–18 was significantly above target.

Obsessed with the deficit and forgetting that what matters is not the deficit per se but the kind of revenues generating measures and expenditure policies that underlie it, Jaitley decided to adopt what is a laudable measure from a social point of view: the reinstatement of a 10% capital gains tax on long-term capital gains in equity markets, or on gains garnered even after holding an investment for one year. That partly helped keep the deficit under control, even if above target. But the reaction of financial capital has been adverse, leading to a sharp fall in equity markets despite investments by domestic financial institutions.

Jaitley failed to secure the full support of finance capital, despite bending over backwards to appease it by not providing resources for so-called “populist” schemes. Investors, foreign and domestic, chose to book profits and exit to cut their “losses” in the form of taxes paid to government. Since this occurred at a time when stock markets were spooked by the threat of a rise in interest rates in the United States and Europe, they tanked. Though the markets have temporarily stabilised at a lower level, the implicit signal is that the political sacrifice made by the finance minister did not deliver the results expected.

Clearly, therefore, the desire of the ruling dispensation to establish that it is more “reformist” than any that has gone before has put it in a bind. It believes you are damned if the fiscal deficit rubicon is crossed. But it is damned even when it does not cross that rubicon, by relying on whatever measures are available in the limited sphere within which it is willing to extend its hand. But what is more significant is that this has frozen macroeconomic policy, foreclosing all options to adopt proactive measures that could make a difference to those who need support.

Politically, this possibly explains the tendency of this regime to launch initiatives or engage in rhetoric whose rationale is difficult to explain or on which it can not really deliver. Demonetisation falls in the former category. Cleaning the Ganga or the whole of India in the latter. Hyperbole can help conceal a reality for some time. But it is no substitute for real measures that make a difference to the common voter.

Updated On : 5th Mar, 2018


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