Budget 2020: India Heads Towards Yet Another Reset Of Its Fiscal Road Map
The Bharatiya Janata Party-led government, when it was first voted to power in 2014, outlined fiscal prudence as a cornerstone of its economic policies.
In his first budget presentation in 2014-15, the late Arun Jaitley, then finance minister, highlighted the importance of this saying, “Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations.”
In the early years, the BJP-led government stuck to this but in more recent years this government, just like its predecessors, has resorted to off-budget spending to meet fiscal goals in letter but not in spirit.
As the government prepares to submit its seventh full budget, concerns about off-budget spending and the ‘real’ fiscal deficit have peaked. Most recently, former Economic Affairs Secretary Subhash Chandra Garg noted that the real deficit in 2018-19 was 4.6 percent compared to the stated deficit of 3.4 percent.
Time To ‘Come Clean’?
Concerns over understatement of fiscal deficit have raised a familiar question for the Indian economy: Is it time to once again alter the fiscal path?
In a conversation with BloombergQuint, Garg said that the current situation presents an opportunity for the government to come clean and to realign the headline and real fiscal deficit.
Divergences between the headline numbers and real numbers are expected to be temporary. History suggests that at some stage, these become large enough to warrant revisiting of the FRBM framework. That stage is reached now.Subhash Chandra Garg, Former Economic Affairs Secretary
The government can decide to peg next year’s fiscal deficit target closer to reality, said Garg, adding that the fiscal deficit can then be brought to 3 percent over the next four to five years.
Soumya Kanti Ghosh, chief economic adviser at State Bank of India, agrees.
The government has no option but to reset the FRBM road map as a target of 3 percent can’t be achieved, Ghosh said. As such, the FRBM has no relevance. According to SBI Economic Research, the headline deficit alone is estimated at 3.8-4 percent of the GDP in FY20, excluding any payments that may come in from telecom-related dues.
Ghosh would prefer the government to present a more realistic fiscal deficit estimate. A lower budget estimate would not be seen as credible by the markets, Ghosh said.
One of the key concerns for any government considering a reset in the fiscal timetable is how it will impact the bond markets.
There are two ways of looking at it. One, since the government and government-owned firms have been borrowing even to fund off-budget spending, the market is well aware of total public sector borrowing requirements. As such, if this borrowing is added back to general government borrowing, the market may not react that adversely.
Devendra Pant, chief economist at India Ratings & Research, said that repercussions on the market maybe limited. Market borrowings by the government and other public sector undertakings are already known and these figures may not change by much, he explained.
Not everyone agrees.
Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. Ltd., said should the government decide to come clean, fiscal deficit would then be significantly higher. The government would then fund the food subsidy bills by issuing government securities. This would come as a surprise for the markets, said Chari. According to Chari, the market remains focused on next year’s fiscal deficit estimate.
Time And Time Again
Should the government choose to reset the fiscal clock, it would not be the first time.
In its original version, the FRBM Act, 2003, mandated a reduction in the fiscal deficit by 0.3 percentage points of GDP each financial year so as to reduce the fiscal deficit to 3 percent of GDP over five years ending on March 31, 2008. The act also prescribed the complete elimination of revenue deficit over this period, along with a check on government borrowings from the RBI.
While the initial years saw saw sharp fiscal consolidation, the global financial crisis led to a break in trend. The target of hitting a fiscal deficit of 3 percent of GDP was first postponed by a year till 2009. It was then ‘paused’ till March 2013, according to the Thirteenth Finance Commission’s report.
In September 2012, a committee led by Vijay Kelkar, suggested that the fiscal deficit be brought down from 5.1 percent in 2012-13 to 4.6 percent by 2013-14 and 3.9 percent in 2014-15. The actual outcome was close to this with the fiscal deficit settling at 4.1 percent of GDP in 2014-15.
Following that, the Fourteenth Finance Commission assessed that the fiscal deficit-GDP ratio will reach 3 percent by 2016-17. That year, the budget revised estimate stood at 3.5 percent. The 3 percent fiscal deficit goal was pushed back to FY18 first and then FY19.
In FY19, the target was pushed back to March 2021.
Doing It Right This Time
Should the government decide to adjust its fiscal path yet again, it should correct some of the flaws which have crept in over time.
For one, the government, following the amendments made in the Finance Bill, 2018, has stopped targeting the revenue deficit target, said NR Bhanumurthy, professor at National Institute of Public Finance and Policy.
According to a paper titled, ‘Fiscal policy, devolution and Indian economy’, which Bhanumurthy co-wrote with Sukanya Bose and Sakshi Satija, an expenditure switch by more than 1 percent of the GDP, in favour of capex, and a corresponding reduction in the revenue deficit makes it possible to combine high growth and fiscal consolidation.
When the economy is slowing and when monetary stimulus is not triggering investments, then there is an urgent need for active and transparent fiscal policy and not a hesitant and confused one.N R Bhanumurthy, Professor, NIPFP
On the basis of its findings, the paper suggests that there is a need to get back to the original FRBM Act of 2003, which suggested targeting both revenue and fiscal deficits.
Bhanumurthy also reiterates the need for an fiscal council. To improve compliance with fiscal targets, successive finance commissions, including the thirteenth and the fourteenth Commissions, proposed the constitution of a fiscal council. Most recently, the N K Singh committee, which reviewed the fiscal road map, also said that an autonomous fiscal council is needed.
While a fiscal council is desirable, its success would depend on the structure and independence, Bhanumurthy said.