In this special pre-Budget series, Ideas for India, star panellists Rakesh Mohan, former Deputy Governor of Reserve Bank of India, Jehangir Aziz, Chief Economist at JPMorgan and Sonal Varma, Chief Economist at Nomura discussed the king of all Budget themes, the fiscal balance.
Below is the verbatim transcript of Rakesh Mohan, Jehangir Aziz and Sonal Varma's interview with Latha Venkatesh on CNBC-TV18.
Q: As a person, when you wore your IMF hat, saw a lot of other economies grappling with similar problems, how sacred should that 3.5 percent target be?
Mohan: It is indeed important for the government to provide credibility to its fiscal programmes. So that once they set targets, it is important that the world at large understands that our government means business in terms of keeping the targets and keeping fiscal prudence as among the top objectives of fiscal policy.
However, having said that I would however say that it is important to give a greater focus on the quality of expenditure and the composition of expenditure. It does seem to me that at the current time, when private investment in India is indeed lagging, given the stressed balance sheets of many of the large segments, the corporate sector and the corresponding stressed balance sheets of
banks, the likelihood of private investment reviving in the coming fiscal year does not seem to be very high.
Therefore, it is very important for the government to step up public investment in a credible and transparent fashion. So, it is in that context that I would say is that it is important that the government provide a clear programmes of public investment in roads, in the railways, in health, in urban infrastructure, in ports and so on both public and private.
However, particularly the public investment but the important point here is that they need to do this in a transparent fashion to say that look last year we spent so much in public investment, this year we are going to spend so much in public investment and provide evidence of a big push and also of course set up the implementation procedures.
If they are able to do that then corresponding with that, one needs to look at the revenue sources for such increases and public investment. That could indeed be either through the IIFCL as of Budget borrowing or I would even say that one could suggest that there should be special infrastructure bonds floated by the government whose proceeds go into the public account which is not lapsable and whose proceeds are only used in public investment. They would be no different from many other bonds but they should be labelled as infrastructure bonds whose proceeds get separated from rest of the Budget.
Q: What is forgivable in the form of fiscal largest, not 3.5, would you be okay 3.6-3.7-3.8-3.9?
Mohan: I don’t want to focus on a particular number. As I said, what is more important are public investment figures and credibility in being able to make their public investments in infrastructure sector.
Q: I still want to tie you down, 3.9 or 3.7 - there is a wide difference. If it is 3.9 or 4, you have not adjusted at all. If it is 3.7 you have shown some tendency?
Mohan: You are not going to succeed in tying me down since I am an independent person now. Let me just at one more point that we do have a tax GDP ratio that is low by any standards, that is lower than comparable economies with similar per capita incomes and so we also need to focus much more on revenue raising in order to increase public investment.
Q: What would your number be and I want a number. I think credibility is very different if it is 3.5 and if it is 3.9? What kind of a fiscal deficit should the government come out with?
Q: Your argument would be?
Aziz: Because anything else is incredulous. Last year, as you pointed out the government said this year we are in pretty bad shape, we need to support the economy, so let us not go the full distance of fiscal consolidation but next year we will do it. Here comes next year. We are going to say, not really, the world is still pretty weak. I am going to do it next year. The question that raises is that if at USD 30 per bbl that this government cannot consolidate 0.5 percentage point of GDP, when can it. And it isn't that the government did not have the revenue. It had 0.5 percentage point of will for Gail from lower than expected which they completely taxed it away. So the fiscal management was not that they didn't have revenue. It is just that they had revenue; they simply did not want to use the other -- privatisation for example wasn't completed. So the fiscal management this year was pretty baffling because if they had actually passed on that 0.5 percentage points of excise taxes to consumers even RBI would say that by their own estimates the average inflation rate would be at least about 100 bps lower. By the RBI's own logic, the RBI would be cutting repo rates by another 100 bps. So here we are stuck in a world which we didn't get any growth advantage; we have higher inflation, we have higher interest rates and even the stock market wasn't buffered by the very inexplicable fiscal management of last year.
I know Dr. Mohan is talking about credibility but there is no real credibility. If they keep on doing the same things as they did last year without changing the framework.
Q: Which side of the debate you are on. Dr. Mohan won't mind something higher than 3.5 which to be substantial should be closer to 3.9. Jehangir is at 3.5. What is your advice?
Varma: One needs to do a cost benefit analysis on slipping versus not slipping and the reason why we are slipping, it is important to consolidate and we also need public investment in infrastructure but the FRBM came into effect in 2003 and we are still struggling to get 2-3 percent of GDP and the reason why we are debating a slip this year is not because of capex but it is because of the Pay Commission which is going to add almost 0.7 percent of GDP Pay Commission and the One Rank One Pension. So the quality of spending is going to happen on the balance sheet in FY17 is not going to be so much pro capital expenditure as we are making it out to be here. Second, the fact that we have been focusing so much on central fiscal deficit but state deficits are also expected to expand in the next couple of years because of their own implementation of the Pay Commission and the UDAY interest payments that they have to make and therefore the aggregate borrowing even by the state government is growing rapidly and therefore the total borrowing by the general government is quite large and large relative to the total demand that we are seeing. So what we do not want is the benefit that we think we will get out of the stimulus, actually ends up being completely offset by the cost that we impose on the economy because of giving out a consumption lead stimulus, partly crowding out other investments which in any case are suffering. So at this stage there is no debate that India needs more public investment in infrastructure but if it is off balance sheet yes. If it can be financed through new revenues sources, yes, why not, but if it is going to come at the cost of slipping on the fiscal front; at this stage the costs are more than the benefits.
Q: Sonal left off the argument by saying that state governments are also going to produce higher fiscal deficit in FY17 because they have to fund the power reforms. A month ago and even few weeks ago the state governments were unable to sell their state development loans even without the excess; the spread with government of India paper which normally was 25 bps went up to 40 bps. So state governments are borrowing at a heavy price, given that do you think that there is appetite for more government bonds even if there is a very good justification. Let me go with 3.8 percent fiscal deficit - that will mean a government borrowing programme which will be at least 25 percent more than what it is estimated for FY16. Will it not come at yields of over 8 percent then will it be worth it?
Mohan: However, again given the circumstances, with the global economy being in the state that is in, the IMF has been revising downwards its predictions, its forecast for global economic growth consistently, if I remember, correcting over the last three years, each and every forecast has been revised downwards. Second, in terms of being able to keep commitments etc, remember that the monetary, huge monetary policy stimulus through unconventional monetary policies in the United States, in Europe, in Japan, their expectations in terms of recovery of the global economy have been belied. So given these conditions where the kind of forecast the IMF has been making for the global economy, the kind of expectations the central banks; the Federal Reserve, the European Central Bank (ECB), the Bank of Japan have been making which have not fructified. It is not surprising that some of our forecasts also do not get fructified. So in that sense we are in a special situation in the global economy and if there is something that the government can do in a credible fashion, both combining the resource raising sides both in terms of off Budget also even on Budget, if you segregate the funds raised from infrastructure bonds even on Budget not off Budget but credibly in a separate account which only goes to infrastructure investment and does seem to be that if you do the communication properly, if you do the implementation properly then it does seem that the market will not react as badly as it might. If you just raise the fiscal deficit without giving that kind of information and that kind of implementation commitments.
Q: Like I told you the appetite was not there this year, the only way the RBI, this time it was 5.15 lakh crore net borrowing and in FY17 it might well be northwards of 5.4 lakh crore, if the fiscal deficit come in at probably 3.8-3.9 percent of the GDP. The point is the only way this can keep the yields below 8 percent is if RBI bought more bonds, did more open market operations, expanded its balance sheet. For me it looks like the only way out. Is that what you want?
Mohan: I would say in the context of the expansion of the RBI's balance sheet that the expansion of the RBI's balance sheet should be proportionate to expansion of the expected growth in the economy as a whole.
Q: That is what it is this year. This year reserve money growth is 11.3 percent. Nominal GDP actually in the first nine months is not even in double digits, so actually even the current year's open market operation (OMO) and reserve money creation is over 11-11.3 percent. Next year if you have to account for a higher bond buying then we will be way above nominal GDP. Are you okay with that?
Mohan: As I am saying these are not one-to-one relationships and they vary, so the only thing I would say is that the RBI does need to make sure that the expansion of its balance sheet is consistent with the kind of monetary programme that they would like to have. It should not do excessive expansion and very clear on that, it should not do excessive expansion of the balance sheet, but nonetheless these are not one-to-one relationships. Those things that you have to make certain judgements and what is feasible, what is credible and what is prudent, so I certainly would not say that the RBI should go all out to expand the balance sheet so that the government's borrowing programme gets done under reasonable basis.
The government does need to get market signals in terms of cost of any kind of higher borrowings. I would not want to do that but nonetheless I do think that it needs to maintain a certain desirable growth by the RBI balance sheet that is consistent for its monetary programme.
Q: This investment capex by the government to ensure GDP because nobody else is investing. What is the total capital expenditure? On non-plan side it is about Rs 1 trillion, less than that estimated FY16 and plan expenditure is another Rs 1.3 lakh crore. Rs 2.3 lakh crore is about 2 percent of the GDP. Does it amount to a huge push to the GDP growth, Rs 2 lakh crore?
Aziz: It doesn’t and I will also disagree that this is the time when we should be pushing for infrastructure investment. Almost every corporate will tell you that the reason why they are not expanding is there is no visibility or sustainable demand. That is where corporate investment is stuck, it is not because the government is not crowding in corporate investment by doing a little bit more of public investment. We tried that this year. What happened? The corporates shrugged it off and they walked away.
We need to figure out what is an alternative sustainable source of demand and the alternative source of demand if it has to be domestic consumption then the structure of public finance needs to change. You cannot go on spending on infrastructure, you need to pass spending on things where the private sector has a huge amount of spending out of pocket, which is health and education where the largest amount of precautionary savings is done by Indian household is in children education and in their own retirement health. That is the place where the investment has to take place. That is where the expenditure has to grow, not building a few more ports.
Q: The other point that both you and Dr Mohan alluded to is the off balance sheet raising of money which can help but wouldn’t that also come at a much higher interest rate? If government bonds within the fiscal deficit limit are themselves being raised at 7.95 percent today, off balance sheet money will come more expensive. Is this an idea that will work?
Varma: I think other than raising more bonds, what I also had in mind was financing also by public sector companies. You mentioned that the aggregate capex by the central government is only about 1.7 percent of GDP. So you are right, it is quite low. But if you add up the capex by state governments and public sector companies, aggregate is closer to 5.5-6 percent of GDP. So I think with centre and state a bit constraint, there will be greater reliance on public sector companies to do capex.
Second is, leveraging on the national infrastructure investment funds, which was there in last year, so if the fund can get more money from the sovereign wealth funds or can government puts in some equity and then the fund raises some debt and can finance some of the infrastructure projects that might not necessarily have a negative impact on the bond market.
Thirdly, also greater reliance on some of the offshore sources of funding for instance, Japan for some of our projects has lent long-term money at very low interest rate. So, if we can tie up for long-term funding at lower interest rates from some foreign sources then we might not see the crowding out of that fearing at this stage.