Fiscal hit fears are for real. Where are resources for growth?

Renu Kohli

The evolving fiscal dynamics threatens to override September’s fiscal reforms and support actions. The government’s action, combined with monetary easing, were seen to spark a recovery from this quarter.

But an intensifying resource crunch and its interplay with persisting economic weakness in October are an alarming sign. The fiscal policy is fast getting trapped between the need to restrain spending and yet boost demand or risk negating monetary stimulation.

Fiscal slippage risks have increased due to a deepening revenue deficit which, in conjunction with fresh financing commitments and corporate tax giveaway, has brought the gap and absence of additional resource-mobilization plans into the spotlight.

The IMF (International Monetary Fund) recently flagged the absence of efforts to offset the revenue impact of corporate tax cuts as well as the need for credible, transparent fiscal numbers in reference to the accumulated off-Budget liabilities and meaningless consolidation.

Then, rating agency Moody’s cut India’s sovereign rating outlook to negative from stable. It cited significant constraints in narrowing the budget deficit to prevent a rise in the debt burden. Moody’s also noted the policy ineffectiveness to address the weak economy, leading to rising risks of lower growth and a more entrenched slowdown. These developments testify to rapid overwhelming of the anticipated positive effects the pro-cyclical policy support by escalating fiscal risks.

Compounding this is a deepening economic slowdown that has fast increased the deficit in taxes collected. During April-September, growth in corporate, personal income taxes and GST turned weaker at a respective 2.3 percent, 8.9 percent, and -1.3 percent against corresponding budgeted targets of 14 percent, 11 percent and 3 percent. The latter understates the revenue gap as actual revenue growth last year was much lower, pushing up the required pace this year.

Tax authorities were recently reported to have requested scaling down income tax revenue target by Rs 1 lakh crore in order to recoup foregone revenues from the corporate tax reduction and offset the slowdown impact. On the expenditure side, revenue spending so far maintained the budgeted pace (14 percent) in the first of the year while public capex has grown 15 percent or more than twice the figure planned for FY20 (6.9 percent).

The benchmark long-bond yield movement is a response to these developments. In November itself, the 10-year yield is 10-11 basis points higher to date over October-end and almost 30 bps (basis points) above the August-end value. The term premium, or extra compensation demanded by investors for holding long-term debt against rolling short-term securities, similarly widened 11 bps this month over October and 50 bps relative to August-end.

One percentage is 100 basis points.

Rising long-term yields directly undermine monetary easing by hardening interest rates and depriving the expected stimulus, besides aggravating the limited transmission that already prevents significant softening of borrowing costs.

The need to prevent long-bond yield from rising will feed into public spending, squeezing it in forthcoming months unless the pre-committed deficit path is breached.

The revenue-expenditure asymmetry will require rectification sooner than later. If matching revenue to restrict the fiscal deficit is not mobilized, spending cuts in the current and/or the next quarter are inevitable. Some signs lead one to speculate that off-Budget borrowings might already be slowing, although there’s little data proof to buttress that at this point.

For instance, firms are reported to be shifting from railways and power sectors to roads, which could indicate a slowdown in the former segments more financed by extra-budgetary resources. Furthermore, core sector output that contracted 5.2 percent year-on-year in September is displaying sequential (three-month moving average of month-on-month growth) contraction in cement, steel and electricity.

The tightening fiscal noose transpires in a worsening economic setting. In October, the manufacturing PMI dropped to a 2-year low. PMI-services continued its contraction and power demand showed the steepest fall in 12 years (-13.2 percent). September data also indicated deterioration such as -4.3 percent shrinkage in industrial output ahead of festive season after a 14-year worst contraction in core sector output (-5.2 percent), fuel demand dropping to its lowest since July 2017, an evenly spread contraction of non-food credit (-0.2 percent) in April-September, and -5.3 percent GST growth outturn.

These developments come at a time when the need for countercyclical demand support cannot be overemphasized. Demand for income tax cuts, increased rural welfare spending to support consumption and bailout for stressed parts of the financial sector to get the economy going abound. The question is of resources – Where can these be found?  Going forward, this will make all the difference to growth.

Renu Kohli is a New Delhi-based macroeconomist. Views are personal.