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Interview | Whether under Indira Gandhi or current dispensation, cooperative federalism has always meant hierarchical federalism: Rathin Roy

Noted economist and former advisor to PM Narendra Modi, Rathin Roy, also said that the centre’s capacity to engage in forward-looking decision making and to deal with the economic fallout of this crisis, is extremely limited.

October 01, 2020 / 03:14 PM IST

India will realistically not come back to 2019-20 real GDP levels until 2022-23, noted Economist Rathin Roy said in an exclusive interaction with Moneycontrol.

Speaking on a number of issues, Roy said that to boost demand in these unprecedented times, spending should come from states rather than the centre, and that the centre’s capacity to engage in forward-looking decision making and to use the institutions under its command, to deal with the economic fallout of this crisis, is extremely limited.

Roy is the Managing Director of Overseas Development Institute and a visiting fellow at the Centre for Policy Research. He was till recently director of National Institute of Public Finance and Policy.

While in that role, he served in the Seventh Pay Commission, the Fiscal Responsibility and Budget Management Committee, and is a former advisor to Prime Minister Narendra Modi.

In the interaction, Roy said that while Modi has aspired for a seamless cooperative federalism between centre and states due to this time as Gujarat Chief Minister, politicians do tend change their mind once they come to the centre.

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Roy also said that a proposed plan to have a fiscal deficit range instead of a fixed point will only give more leeway to an ‘increasingly more incompetent’ Finance Ministry bureaucracy unless backed by sound economic reasoning.

Edited excerpts:

Given the extent of April-June GDP contraction, what are your expectations for FY2020-21. Most economists expect all four quarters to show contraction, while the Finance Ministry still talks about a V-shaped recovery in the second half of the year. What are your views?

There is a lot of confusion about this, because of this unfortunate use of alphabets, which are not a standard part of the toolkit of a professional economist. They are essentially descriptive analogies. So, what matters is the analysis behind them. I'm not going to join people who just assert a letter of the alphabet like V or U. It depends on what your benchmark is, and my benchmark is the level of GDP in 2019-20. So, now, the question is when will we come back to that level of GDP?

So, coming back to that level of GDP would describe a V. But how big a V and what is the distance between the two axes of the V is the more interesting question. So, in that sense, it is trivial to say that we will have a V shaped-recovery. Of course, we will, we are an emerging economy.

I think it is absolutely clear to everybody with the simplest intelligence, that we will not be at FY20 real GDP levels in FY21. My estimate is that if things go on as they are and assuming that the COVID-19 impact on the economy in terms of both the demand and the supply side starts to moderate by January 2021, then I do not see the economy recovering to FY20 real GDP levels before optimistically 2021-22, but more likely 2022-23.

Many economists have been saying that the time for the government to announce further fiscal stimulus measures and spend more is now, while the government says while it is aware of this need, the timing is yet to be decided. Your views?

One plausible reason why the central government may not be spending the money is that is not confident of spending it well. Because the most dangerous thing you can do in this circumstance is to increase fiscal space, allocate money to something and then see it misspent.

Take infrastructure, you may declare you intend to spend money on infrastructure but suppose your spending does not occur in the timeline in which we expect the infrastructure output should result, then the expected impact on aggregate demand will not happen.

So the government perhaps is thinking outside the textbook and saying that I'm not going to spend more because I know that if I spend more, that spending will not be effective. So the best I can do is put money into people's bank accounts, and get them to spend more. And if they don't spend more than the same, then I work on the credit policy side.

Now assuming that that is not true, then the logical place for the spending to happen on the demand side would be for the state governments to do so. But since there seems to be an unwillingness to give the state governments money, unless they borrow it themselves, that avenue is also closed. And anything that the centre does other than putting money into bank accounts of people to directly increase aggregate demand is going to be limited in impact.

There are differences between the centre and the states in the GST Council, the CAG has said the centre broke law by transferring money from compensation cess fund to the Consolidated Fund of India, and the Reserve Bank of India has postponed its Monetary Policy Committee meeting. What do these things tell us about our economic policymaking?

It tells us that that the government’s capacity to engage in forward-looking decision making and to use the institutions under its command, to deal with the economic fallout of this crisis, is extremely limited.

The Prime Minister, the Finance Minister, and her predecessor have all spoken of ‘cooperative federalism’. Is that under threat, especially given what is happening in the GST Council and the way the farm bills were passed?

I think cooperative federalism was an aspiration of the Prime Minister, perhaps coming from the long time he spent as a Chief Minister. But the fact remains that much like civil servants who assume positions of Constitutional office, even politicians change their mind once they come to the centre.

And it is regrettable that in the history of this country, whether under Indira Gandhi or the current dispensation, cooperative federalism always has meant effectively, hierarchical federalism, with cooperation from the states.

But most states have agreed to take the first of the two options presented to them in lieu of compensation shortfall, by the GST Council.

There was no third option on the table. There was no offer of interest free money. It is a well known fact that when the states borrow, then the central government, in principle makes money. Because when the states borrow, the interest on those loans are paid to those who hold state bonds.

A large proportion of which are public sector banks and other financial institutions which are owned by the central government. If they borrow directly from the RBI, in case that happens, it's even worse, because that goes directly to contribute to the profits of the RBI. So when the states borrow, the centre makes money, and that is not a desirable state of affairs. But under compulsion, I suppose the states have no option.

The 15th Finance Commission chairman NK Singh, with whom you have worked closely in the FRBM committee, has spoken of a fiscal deficit range instead of a fixed target. Is that desirable or needed?

There is a bit of wishful thinking going on here. So let us say that the fiscal deficit range would be from 3-4 percent. What would be the logic of taking the fiscal deficit down to 3 percent in a situation where the central government is severely constrained for money. When the tax-GDP ratios have been falling consistently for the last four years, when the entire tax base has shrunk thanks to COVID-19, there would be very little logic to it. And therefore, the tendency would be to stay at the top of the range.

The second consideration is even if I gave a range, what will be the effective sanction if the government breaks that range? The third, is there a desirable fiscal deficit? In my book, unless there are regressive implications to taxation, an ideal situation would be that all government expenditures be funded through taxation and non tax revenue

As a professional economist, as opposed to administrator, I would need to understand the logic by which the range has been set before I can see whether it'll work or not. Otherwise, I can tell you as a policy person, that what you will have to do is either live with the top of the range, in which case you effectively have a fixed point. But it makes your average, increasingly less competent, finance bureaucrats happy that they can announce in Parliament that they're within the range. Or like the monetary policy committee, you will have to make a commitment to stay at the midpoint.

I believe that the deficit occurs for structural reasons, so I look forward to some structural economic theory. But since I have not seen the economic theory underlying the Finance Commission’s, ruminations in the event that they do go for a range, I would only comment on it after looking at economic theory, or the analytical framework that justifies it. I would not be looking for administrative arguments, I would not be looking for arguments of convenience, I will be looking for analytical justifications.

Successive governments have breached the fiscal deficit targets over the years, and the medium term target of 3 per cent of GDP has never been reached. Does the FRBM Act need more teeth?

You see, you cannot have any penalties on a weak government. If the underlying reason why the government keeps slipping on deficit targets is revenue performance, and inflated expectations from non tax revenue including divestment, then the government will not be able to meet its FRBM targets.

There are only two things you could do to make a government accountable to its targets, neither of which the government will do, because that would make the bureaucracy in the Finance Ministry accountable. The first is to go for three year medium term fiscal framework. The second is the one recommendation (of the FRBM panel) that the bureaucracy killed, and that is a fiscal council. I happen to know that the late Mr Jaitley was neither for nor against it, so it was clearly done on bureaucratic advice.

Those two institutional reforms would have resulted in the government having to justify repeated deviations from fiscal commitments. Only an institutional reform of the Indian budgeting process, accompanied by institutional reform in the Finance Ministry, in with something like the fiscal council as a purely technical body with no powers, was setup would give you that kind of institutional accountability and foresight that would enable the country to be more competent in the execution of its fiscal policy. In the presence of incompetent execution, the FRBM is not a worthwhile cause.

Arup Roychoudhury
first published: Oct 1, 2020 03:14 pm