Faster reduction in fiscal deficit will send 'very good signal': MPC's Ashima Goyal

Ashima Goyal is one of the three external members on the Reserve Bank of India’s Monetary Policy Committee.

A faster-than-targeted fall in the fiscal deficit will send a "very good signal", said Ashima Goyal, one of the three external members on the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC).

"Fiscal policy should be counter-cyclical, and build buffers to be able to spend more in bad times. A faster reduction will send a very good signal," Goyal told Moneycontrol following the release of the minutes of the December 6-8 meeting of the MPC, on December 22.

Also Read: Steady progress on inflation, but next steps are crucial

The rate-setter's comments come just over a month before Finance Minister Nirmala Sitharaman presents the 2024-25 interim budget on February 1, with the Lok Sabha elections expected to be held in the second quarter of 2024. While the finance ministry is seen to be meeting this year's fiscal deficit target of 5.9 percent of GDP, it will have to target a significant reduction next year if it wants to achieve its medium-term objective of reducing the deficit to 4.5 percent by 2025-26.

"Steady reduction in government debt to East Asian levels will improve Indian ratings, reduce risk premiums and the cost of borrowing abroad. It will also show how unfounded is the IMF prediction that Indian government debt is likely to exceed 100 percent of GDP from current levels of 81 percent," Goyal added, referring to the IMF's (International Monetary Fund) observations in its recent Article IV consultation report that given the shocks India has faced, its debt-to-GDP ratio could exceed 100 percent in the medium term.

According to IMF data, India's general government debt – Centre plus states – in 2022 stood at 81 percent of its GDP, well above the figures for East Asian countries such as Vietnam (39 percent), Indonesia (40 percent), Philippines (58 percent), Thailand (61 percent), and Malaysia (66 percent).

More immediately, Goyal thinks the Centre "should not be tempted to overspend" on account of buoyant tax revenues. "This is what unfortunately happened in the high growth period the 2000s, and led to the macroeconomic vulnerabilities of the 2010s", she said, adding that the interim budget should continue to focus on building physical and human capital — areas that see sub-optimal private investment. However, she also sees "well-designed incentives" and better governance resulting in better outcomes, even if the expenditure is lower.

"For example, we have universal school enrolment and new colleges and universities are mushrooming, but attention now has to be paid to the quality of education. More delegation to the third-tier and accountability to the user will help improve public services," Goyal explained.

Inflation and rate cuts

Days after Goyal and her fellow MPC members left the repo rate unchanged at 6.5 percent for the fifth meeting in a row, statistics ministry data showed that the headline retail inflation rate had jumped to a three-month high of 5.55 percent in November. However, not only was the print lower than expected, Consumer Price Index (CPI) inflation is seen to be easing in 2024, with the RBI pegging it at 4 percent in July-September 2024.

In her statement in the minutes of the December 6-8 meeting, Goyal warned that if inflation moves towards the medium-term target of 4 percent in a sustainable manner by mid-2024, real interest rates "can easily become too high if nothing is done".

In her interview with Moneycontrol, Goyal clarified that by 'if nothing is done' she was referring to rate cuts. At the same time, she warned that commodity shocks in the past had stopped the RBI's inflation forecasts from approaching 4 percent. Therefore, it is essential the MPC waits for more data to confirm that the inflation downtrend is sustaining. "Data coming in the next few months is not expected to lead to a rise in forecasts," she added.

While headline inflation rose in November, core CPI inflation eased to 4.1 percent. According to Goyal, Emeritus Professor at Mumbai's Indira Gandhi Institute of Development Research, falling core inflation suggests the output gap is not yet positive.

Also Read: India's 'output gap' is now positive, says RBI bulletin

Output gap is the difference between an economy's actual output and what it can potentially produce. When the gap is positive, it can lead to demand-pull inflationary pressures.

Asked if the MPC should target core inflation instead of the headline number, which is heavily influenced by volatile food prices, Goyal pointed out that the headline inflation number is key as it impacts consumer welfare, household inflation expectations, and second-round inflationary effects (price and wage hikes by firms in response to increase in prices of items such as food and fuel). As such, reducing headline inflation is a "valid social goal," she said.

Smaller food basket

At the same time, the large weight of food and commodities in the CPI basket means supply-side measures and co-ordination between fiscal and monetary authorities "is the way to reduce inflation with the least growth sacrifice," Goyal noted.

The increase in retail inflation in November was driven primarily by an unfavourable base effect and a rise in food prices, particularly of vegetables, which propelled food inflation to 8.7 percent from 6.61 percent in October. However, Goyal sees some positives in India's overall food inflation dynamics.

"Although volatility has increased, its persistence and pass-through to core inflation has fallen. Under mature inflation targeting, transient supply shocks can be overlooked as inflation expectations stay anchored. We seem to be getting there," she explained.

Also Read: RBI may have to wait until 2026 for updated CPI inflation series

What may be helping reduce the pass-through of food inflation to headline inflation may be the fact that the weight of food items in a consumer's basket is lower than what the CPI assumes.

"On average, food now comprises about 30 percent of the consumption basket. So second round pass-through from food to core inflation is lower. The vulnerable sections, for whom food still dominates consumption, are getting free food," she added.

Per the current CPI series, the 'food and beverages' group makes up 45.86 percent of the basket. However, the consumption basket measured by the CPI has not been updated in more than a decade.