Budgets, Truth, Painkillers & Remedies

(The following article appeared on CNBCTV18 on July 5, per link below:

https://www.cnbctv18.com/economy/union-budget-2019-truth-painkillers-and-remedies-3896851.htm)

Budgets, Truth, Painkillers & Remedies

Finance Minister Nirmala Sitharaman is in an unenviable position.

First, the extent and quality of the fiscal imbalance she inherits is far worse than is acknowledged. 

Second, she has promises to keep, which will stretch the fiscal math even further.

Third, the economy is hurting. Many analysts, companies and whole sectors are clamoring for tax breaks, bailouts and lower interest rates – effectively, asking for looser fiscal and monetary policy. 

Strangely, this appears to be a great time for governments to print money and spend it. Every other country seems to be doing it anyway. Those that warn that this has always ended badly – in one or more of currency volatility, inflation or financial instability – sound like cranky old doomsayers. 

While we ponder this seemingly easy way out, the much-needed real and tough remedies – including land reforms, labor reforms, power sector reforms, financial sector reforms and increased investments into the future of our children – may be taking a backseat. 

Hopefully, we don’t wait for a full-blown economic crisis before we embark on these. 

In the meantime, countries such as Vietnam, Taiwan and Bangladesh are grabbing the many global opportunities that should be ours to tap.

Can We Handle the Truth? Of real deficits, revenue deficits and monetization

Data for full-year fiscal year 2018-19 (FY19) show that receipts were INR 1.6 tn (0.9% of GDP) lower than projected, with tax collections severely disappointing. 

Despite this revenue shortfall, the fiscal deficit was practically unchanged, with the government saying it spent INR 1.5 tn lower than budgeted. 

This lower spending appears to be an accounting smokescreen, rather than actual austerity. As an example, the past two years, the government has simply not paid its bills in full to its own entities such as the Food Corporation of India (FCI). Since the government follows cash accounting, if it doesn’t pay its bill, it doesn’t recognize any expense either. 

FCI alone now has accumulated debt of INR 1.96 tn (1% of GDP), in lieu of government payments. Other central and state entities have substantial borrowings as well, to make up for the government not paying them.

If we adjust for all this, for FY19 alone, the actual deficit may have been 1% of GDP higher than the headline 3.4% of GDP. The cumulative hidden deficits across the center and state governments may be well over 2.5% of GDP. 

Much of these hidden expenses are on the revenue account, rather than capital expenditure. We are currently spending off our children, not for them.

Lastly, in FY19, the RBI purchased 67% of the net debt issued by the central government, in order to infuse liquidity. Whatever be the intent and context, such large purchases by the central bank take on the color of fiscal deficit monetization. Print and spend may already be underway.

Promises to Keep

Even while our FM will not kitchen sink her own government’s books, there are increased demands for stretching the fiscal math even further.

First, given very tepid actual revenue collections in FY19, the revenue projections for FY20 will have to be brought down from the February 1 projections.

Second, the ruling party manifesto has promised to lower taxes, increase social spending and increase investments. 

Third, the economy is in distress. Sectors such as financial services, real estate, construction, auto, power, telecom, airlines and shipping have made the case for fiscal and monetary relief. Some warn of a full-blown crisis. This is a tough time to limit fiscal expansion, let alone advocate austerity.

As ever, there are ways out. For one, the government could explore ways of raising its receipts by aggressive sell down of government assets. 

For another, the government could continue to print and spend.

A Whole New World of Economics?

There is strong case to suggest that in the current context, we can get away with simultaneous fiscal and monetary easing – at least for now.

After all, our inflation is low, crude oil prices are manageable, our currency is strengthening, much of our debt is domestic, and global central banks are pursuing easy monetary policy. Every other country appears to be pursuing loose monetary and fiscal policy, and markets don't seem to mind. 

Is this time different, and is economic theory being rewritten? Maybe. But we have to remember that history is replete with episodes where sustained periods of fiscal and monetary loosening eventually tested India’s currency markets and external balance, inflation, banking systems and overall financial stability. 

Even as we provide fiscal and monetary relief, maybe we would do well to be cautious, improve the quality of our spending, and address the core issues that dog the economy. 

An Armchair Commentator’s Prescriptions

First, perhaps there is a case to enforce cost cuts in revenue expenditures and divert the savings into productive capital expenditure – into water, irrigation, Make in India, Skill India, Smart Cities, Digital India and other key initiatives. 

In FY19, just 5% cut in revenue expenditure could have diverted INR 1.2 tn into productive capital spending. Even the staunchest fiscal hawk would admit that with the right spending mix, the comfort around the sustainability of deficits would improve dramatically. 

As a corollary, we have to bring back the focus on sharply reducing our revenue deficits – our borrowings off our children, just to fund current expenditures. The 2018 amendment to the Fiscal Responsibility and Budget Management (FRBM) act that took away this focus needs to be reversed. 

Second, perhaps there is a strong case to focus on real factor reforms – land, labor and capital. These are very tough reforms, but there may be no alternative to pursuing them to improve our manufacturing, exports, and employment prospects. We are losing out to the likes of Bangladesh and Vietnam, where businessfolk report far easier and flexible access to all these key factors of production. These reforms may be inevitable, and perhaps we would be better off pursuing them now, rather than after a full-blown crisis.

Specifically, we have to clean up our financial services ecosystem. Much of it appears to be focused on solving stressed lending of the past, rather than on financing new opportunities. We need to ring-fence stressed assets and resolve them separately, capitalize the healthy part of the ecosystem, and undertake true reform their management and governance. These are admittedly daunting boil-the-ocean challenges, but we cannot let the size of the task deter us. 

Likewise, we know of deep and lingering issues in specific areas such as the power and real estate sectors. We cannot continue to kick these cans down the road – we have to lock stakeholders up in a room and refuse to open it, till a durable, real solution has been found. 

Conclusion

Mrs. Sitharaman has a very tough job on her hands – but by providing some relief, being cognizant of the risks, focusing on productive capital spending, and undertaking real factor and sector reform, she can yet overcome the many threats and help us capitalize on our many opportunities.