The gravity of economic problems shows that the next government will find it very difficult to rally the usual macroeconomic responses to support growth.
Five years ago when the National Democratic Alliance (NDA) government took over, reviving growth was a major concern. Five years later, economic revival is again at the centre stage. All agencies predict growth to slow down; the International Monetary Fund (IMF) is the latest soothsayer. But the options for the next government to push growth are limited.
In 2014, the consensus was for a pause in fiscal consolidation to create room to support demand as monetary policy was focused on price stability. The optimal policy response mix for growth support in 2019 would depend on the conservative fiscal and monetary policy spaces available. The new government will also have to look at the nature of underlying issues.
On the fiscal front, the trade-off between supporting demand and keeping public debt and deficits on a sustainable path heavily weighs towards the latter. In 2019, the fiscal situation is much worse compared to 2014. The overall revenue shortfall is reported to be around Rs 1 lakh crore for 2018-19 — direct tax revenues are short by Rs 50,000 crore. This will force downward revisions in the interim budget targets when the full budget for 2019-20 is presented. Goods and Services Tax (GST) revenues have grown 9.6 percent year-on-year in August-March 2019, which is below the nominal GDP growth.
Revenue pressures will intensify with slowing consumption and production, and electoral giveaways like an increase in the personal tax exemption threshold. There is little leeway to increase non-tax revenues owing to the heavy extraction of dividends. Share buybacks in the last five years has pushed non-oil public sector units into net losses for two consecutive years to 2018-19. Disinvestments remain uncertain and dependent on market conditions leaving the RBI as the only major, steady source of dividend revenues.
This is just the budgetary picture. The play outside the budget is far worse. Cumulative off-budget financing of revenue expenditure is at high levels. Subsidy-related liabilities aggregated Rs1.29 lakh crore (0.85 percent of GDP) in 2016-17 according to CAG; total liabilities due to capex funded by fresh borrowings (National Small Savings Fund (NSSF), LIC, banks, bond market) were Rs 3.05 lakh crore or 2 percent of GDP. These have risen further. The Food Corporation of India’s cumulative NSSF borrowings alone is at Rs 1.8 lakh crore.
The large-scale diversion of scarce financial resources is pushing up interest rates. The long-bond yield is astonishingly high from escalated fiscal risks despite low inflation. Recurrent revenue expenditure is high and fresh electoral commitments to alleviate farm distress will further add to it. Therefore, the fiscal space for demand support is simply unavailable. In fact, public capex will face more cuts to accommodate increased revenue spending.
What about monetary policy? The adverse, crowding-out effect of public sector borrowings negates monetary easing, which is also constrained by weak deposit growth that blocks transmission. Monetary policy is tied to a headline inflation target but finds it difficult to ignore stronger core inflation. Substantial easing will depend on oil price, global volatility and fiscal risks.
What are the pressing issues underlying the slowdown?
Topping the list is financial system stress and vulnerabilities. A persisting debt overhang because of slow resolution of bad loans; unresolved regulatory issues and unsuccessful reforms in the power sector; new NPA additions in infrastructure, MSMEs and from the fast-growing Mudra loans; fresh strains and fault lines uncovered in non-banking segment by the ILF&S’ failure; and the failure to reform and explain the precise role of public banks are major sources of concern.
The insufficient recapitalization of public sector banks needs urgent attention, implying more claims upon stretched fiscal resources. The failure to prioritize recapitalization at the start of its tenure by the outgoing government—especially since it had the windfall of oil revenues— has prolonged the impasse. More pressures in the telecom, aviation and infrastructure sectors, with associated failures of a large airline, a media-cum-infrastructure conglomerate, and others expose economic weaknesses where unrealistic prop-up attempts could result in cave-ins or spillovers.
The gravity of economic problems, combined with the dearth of policy space, indicate the next government will find it very difficult to rally the usual macroeconomic responses to support growth. Taxes and spending would have to adjust, making hard decisions inevitable. As for monetary policy, let us not forget that two tightening-easing cycles mostly skipped past the banks in the last five years. So addressing the long-standing stasis in public banks is a necessary condition for its effectiveness.
In 2014, the new government could deploy public capex and a tight monetary policy to spur growth. But the incoming government of 2019 may have neither the luxury of fiscal stimulation nor much monetary easing despite the low inflation.(Renu Kohli is a New Delhi based macroeconomist.)
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