Saugata Bhattacharya
Cumulating signals of a growth revival after October suggest a shallow recovery. Policy support is needed to accelerate the recovery. Scope for further direct monetary policy easing in the near term is limited, given inflation concerns, howsoever transient. The Reserve Bank of India (RBI) is still likely to continue to use innovative solutions to lower the cost of funds for borrowers.
Hence, attention has now turned to a fiscal stimulus. Higher government spending is needed both for consumption demand and investment. Although improving, impaired balance sheets of corporates, non-bank lenders and households will impede a near-term private expenditure-based recovery. Unfortunately, the room here too seems limited. Whatever the final numbers for FY20, this year is more or less done. The focus is now on FY21.
First, as a technicality, can the Centre breach -- and by how much -- the FY20 BE (budget estimate) fiscal deficit of 3.3 per cent? Both the original FRBM (Fiscal Responsibility and Budget Management) Act and the NK Singh Review Committee recognised the need for counter-cyclical fiscal support and allowed a slippage of 0.5 per cent provided real growth in any quarter falls 3 percentage points below the moving average of the preceding four quarters. This would require Q3 growth to print at 2.5 per cent, since GDP (gross domestic product) growth averaged 5.5 per cent between Q3FY19 and Q2FY20. This is unlikely.
Other escape clauses allow slippage in case of, inter alia, structural reforms with unanticipated fiscal consequences. This might be invoked, citing the corporation tax cut with fiscal implications unanticipated during BE. Hence, RE (revised estimate) deficit will set the possible range for the FY21deficit.
Second, with somewhat higher inflation, FY21 nominal growth is likely to be projected at 9-10 per cent, and allowing additional buoyancy in most tax heads, incremental revenues are certainly possible. In addition, higher non-tax revenues through divesting not just public-owned companies, but also monetising assets of various infrastructure and project SPVs (special purpose vehicles), will add to receipts.
However, spending needs are likely to outpace revenues. Higher expenditure and therefore a higher deficit will entail increased borrowings. Although access to multiple sources is possible, concerns about a large issuance of government bonds in FY21 of over Rs 8 lakh crore (due to very high redemptions of maturing papers) has the potential to push interest rates on such securities significantly higher.
There are two remedies to control yields. One, a new set of buyers to balance the higher supply, which in effect means opening up the G-sec market to foreign investors. Two, RBI’s support via buying bonds through OMOs (open market operations) as was done in FY19. But beyond a certain amount, this will be perceived as monetising the deficit. In addition, OMO bond buys will add to the current high liquidity -- which is expected to remain in surplus for much of FY21, even if at lower levels -- requiring counter actions like the innovative “Operation Twist”.
In addition, extensive use of shorter-term borrowings like Ways and Means Advances (WMAs) and T-bills will allow for higher spending. Higher borrowings from to the National Small Savings Fund (NSSF) and shifting some of the expenditure heads to the NSSF are other ways of keeping spends higher without a concomitant rise in borrowing costs, although each of these channels will entail a cost, either in impeded transmission or higher than prudent liquidity levels or some other risks.
Assuming a coordinated approach to manage the potentially higher spends, how should the spends be allocated to maximise the most efficient demand boost and growth stimulus? The four large broad competing demands – among many – for the higher spends are (i) expand both rural transfers and spends on rural infrastructure (ii) a personal income tax cut for a carefully targeted middle class segments to boost urban demand (iii) accelerate payments and refunds due to corporates, particularly MSME, including settlements and resolutions of amounts under dispute -- a process already initiated -- and (iv) (and this is the most ambiguous) a corpus for a bad bank to clean up the balance sheets of banks. A credit revival will be crucial. Detailed analysis of the trade-offs will be needed for this.
Finally, enhancing the efficiency of government spending is and should be an ongoing initiative and should be implemented more aggressively, irrespective of the stage of the economic or fiscal cycle. A relook and rationalisation of government programmes to cut overlaps, duplication of spends and waste is likely to lead to deep long-run benefits.
Saugata Bhattacharya is Senior Vice-President, Business and Economic Research, Axis Bank. Views are personal.
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