Not the time for aggressive fiscal consolidation: MPC's Ashima Goyal

The Centre's fiscal deficit target for the current financial year is 6.4 percent of GDP.

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While there is pressure on the government to reduce its pandemic-era largesse, a sharp slowdown in global growth due to rapid tightening of monetary policy across the world is tipped to weaken the Indian economy too. Initial signs are already visible, with India's merchandise exports down 17 percent in October and November seeing only a marginal rise of 0.6 percent.

The slowdown in external demand for India's goods comes at a time when the domestic investment cycle is yet to take hold. This, according to Goyal, means the government must continue its push on infrastructure to crowd in private investment and reduce costs and bottlenecks in the economy.

While the RBI has forecast a GDP growth rate of 6.5 percent for 2023-24, Goyal is of the opinion that though 7 percent would be "good", 6 percent "may be more feasible".

Fiscal fortunes

Goyal is optimistic about the government's finances even as she sees the need for it to push capex. Key to this view are the buoyant tax revenues, which should give the government room to meet its commitments and reduce fiscal deficits.

Beyond next year, the prospects for the government look good. Last month, Goyal had remarked it is "highly doable" for the Centre to lower its fiscal deficit to 4.5 percent by 2025-26, as per the revised medium-term path announced after the pandemic struck.

As for the original fiscal deficit target of 3 percent, Goyal remains unfazed.

"The combination of tax buoyancy and tax reform under growth that smoothly exceeds the real interest rate will allow this target to be easily achieved. Growth in tax revenues in the first half of this year was about 50 percent more than in the pre-COVID period," she said.

However, she emphasised that countercyclical expenditures are required instead of repeating the mistake of the 2000s – spending more as tax revenues rise.

"Countercyclical policy protects from shocks, but builds buffers in good times. Food and fertiliser subsidies can be phased out as oil prices fall, as part of improving the composition and efficacy of government expenditure," she added.

Policy nuance

If a countercyclical fiscal policy is crucial, Goyal said monetary policy will be data-based.

"There are wide uncertainty bands for both growth and inflation forecasts. Policy can be suitably fine-tuned as incoming data affects forecasts. In my view, in order to maintain a fine balance between reducing inflation without hurting growth the ex-ante real rate should not rise above 1 percent," the Emeritus Professor of Economics at Mumbai's Indira Gandhi Institute for Development Research, said.

An ex-ante real rate refers to a real rate of interest computed using forecasts. With the RBI currently expecting Consumer Price Index (CPI) inflation to average 5.4 percent in July-September 2023, a repo rate of 6.25 percent results in an ex-ante real rate of 85 basis points – just 15 basis points below Goyal's 1 percent figure.

One basis point is a hundredth of a percentage point.

While the real rate may be approaching Goyal's threshold, the policy stance is already at it.

At the December 5-7 meeting, Goyal joined fellow external member Jayanth Varma in voting against the MPC's language on remaining focussed on withdrawal of accommodation.

Both Goyal and Varma want the stance to be shifted to neutral.

"Perhaps the RBI feels 'withdrawal' is better to communicate its continued vigilance on inflation. I favoured 'neutral' in order to signal liquidity support in these difficult times of quantitative tightening and because of my analysis that inflation was softening while the risks to growth were rising," Goyal reasoned.

"These are complex issues. The minutes give different perspectives so that analysts and markets can form their own judgement. Communication tends to be more challenging, and views more varied, as a policy pivot approaches," she added.

Headline and core

A sharp fall in recent months has seen CPI inflation retreat to within the RBI's 2-6 percent tolerance band for the first time in 2022, with the November inflation print of 5.88 percent more than 150 bps lower than what it was just two months ago.

With food prices driving this fall, Goyal said the inflation trajectory had to be watched for some more time.

Asked to comment on whether two years was an appropriate timeframe to bring headline inflation down to the medium-term target of 4 percent, Goyal said it is important to wait out the current global uncertainty.

"Two years should give enough (time) for that to play out," she said.

While the November headline inflation print was released after the MPC's December 7 rate hike, the decision day was dominated by the emphasis on core inflation and the need to break its persistence around the 6 percent mark.

"There is more concern about the persistence in core inflation. In my view, however, this is due to the multiple supply shocks we have been living through. There is no true second round pass-through due to rising wages, excess broad money growth or excess demand," Goyal said, adding that both headline and core inflation should see sustainable fall as global commodity prices soften and domestic supply conditions improve.

The MPC's increased emphasis on core inflation comes shortly after Goyal argued in a paper that core inflation could be a better target than the headline retail inflation rate.

"A central bank's policy rate transmission channel affects core more than headline, which is why I favoured a core target in the early stages to better establish the credibility of policy actions," Goyal said.

Pointing out that as food items had a large weight in India's overall CPI basket, it made it more amenable to fiscal action.

"Therefore, with a headline target, there is more responsibility on the government for inflation management. Since the government is taking appropriate action, headline CPI can also be a credible target. The free food programme is one reason there is no second-round rise in rural wages."

"The MPC has to follow the mandate given to it," she added.