A fiscal collapse is in the offing for India
In a surprise move, the Government of India (GoI) in consultation with the RBI has enhanced the magnitude of its gross market borrowing programme to ₹12 lakh crore for fiscal 2021, an increase of 54 per cent over the budgeted market borrowings of the same year. The announcement came on in a RBI press release issued on May 8. It may be mentioned that the market was expecting some slippages, but not of such a magnitude.
The result is a coming collapse of a kind that we haven’t seen since the oil shock of the early 1970s.
The revision was necessitated, as the authorities claim, in the light of the Covid-19 pandemic. The impact of such an upward revision has many repercussions, even accounting for the unusual situation caused by the pandemic and the resultant and expected toll on fiscal prudence in terms of the FRBM deficit and debt targets. This is over and above the agreement reached by mutual consultation that the Ways and Means Advances (WMA) to the Union government, which is ideally meant to meet the sudden and unexpected increase cash deficit of the government, be substantially revised earlier to ₹1,20,000 crore, a jump of 60 per cent.
In the above context, it is important to mention that our fiscal position is weak, and there is no fiscal space. Besides, our past experiences suggest that fiscal slippages and the lack of fiscal integrity has become a routine affair even under the FRBM regime. As an illustration, we may look at the latest actual data from the Controller General of Accounts (CGA) between April 2019-February 2020. The fiscal deficit and revenue deficit were 135.2 per cent and 156.5 per cent of the budgeted amount, respectively. This was a pre-Covid situation. Disinvestment proceeds recorded a shortfall of nearly half (₹35,243 crore) during this period as against ₹65,000 crore in the revised estimates.
In short, the fiscal situation was weak. This weak body is being dealt a blow of unprecedented magnitude by the pandemic. The result is a coming collapse of a kind that we haven’t seen since the oil shock of the early 1970s.
The additional market borrowings by the GoI has many repercussions, even accounting for the unusual situation caused by the pandemic and the resultant and expected toll on fiscal prudence in terms of the FRBM deficit and debt targets.
The additional market borrowings by the GoI will have manifold repercussions. They will set off a chain of cascading effects that will bring in challenges that will test the fortitude, maturity and foresight of policymakers.
Consider that given the massive slowdown in economic growth in real terms to 1.9 per cent (IMF estimates for calendar 2020), the nominal growth will also witness a slowdown and could be at 5-6 per cent (from 11 per cent projected in the Union Budget of 2020-21), given the inflation rate of around 4 per cent or a shade lower than that. Such a deceleration in nominal growth will have adverse implication on savings and particularly financial savings.
The IMF estimate itself is outdated and a view is emerging that real growth may be negative, given that the pandemic is now seen as extracting a higher toll. The slowdown in financial savings will impact the market borrowing programme of the government in terms of higher interest rates. Higher bond yield rates will thus impact the yield curve. More importantly, the bond rates remaining much above the policy repo rate and longer-term repo rate will completely break the monetary policy transmission, which is already weak.
Bond rates remaining much above the policy repo rate and longer-term repo rate will completely break the monetary policy transmission, which is already weak.
With the broken transmission, the entire effort of the RBI to revive growth through the interest rate channel will be jeopardised. In sum, it all comes down to naught on the single point agenda of reviving growth.
Government balance sheet
In order to address the helpless monetary policy and to arrest the increase in interest rate, as the market is indeed expecting, the RBI and the GoI will take the shelter in an escape clause of the FRBM Act and permit the RBI to support the market borrowing programme by allowing it to participate in the primary market auction, which has been prohibited since April 1, 2006, in accordance with the provisions of the FRBM Act. This option will be preferred, as paying commission to primary dealers will be costlier. Such a move, if implemented, will obviously be against the one golden rule (borrowing rule) of the FRBM Act.
Besides, the RBI balance sheet will be tainted with a large amount of government bonds and the increase in the Net Domestic Assets (NDA) will fuel the currency in circulation, thus making the economy more susceptible to the potential danger of inflation. Already, there is a potential threat to inflation from the supply shocks and shortages due to production losses in agriculture and in the manufacturing sector.
RBI balance sheet will be tainted with a large amount of government bonds and the increase in the Net Domestic Assets (NDA) will fuel the currency in circulation, thus making the economy more susceptible to the potential danger of inflation.
India is a federal country. The State and Central government are co-dependent as per the mandate of the Constitution. The State government, being closer to the citizens, has more expenditure responsibilities; and Central government has more taxation power, as it has the ability to raise resources as a sovereign body. Due to the massive slowdown in economic growth, tax collections will be affected adversely, and in turn, there will be a substantial deceleration of resource transfer to State governments in terms of the devolution of taxes and transfer of grants. Besides, the own taxes of the State government will also be severely affected and the adverse impact will be more pronounced in case of State GST.
These developments ipso facto will necessitate higher borrowings by State governments also. According to Article 293(3) of the Constitution, the State government needs the approval of the Central government for raising the resources from the market. In the event of strict monitoring of the market borrowing programme of the State government by the GoI, there will be two options left for the States viz to take loans from the banks for its undertakings by providing guarantees; and take recourse to WMA from RBI and overdrafts. In the former case, there will be increase in contingent liabilities, and in the latter, monetisation of deficit. Both are bad.
In this new world, with the back of the economy broken, fiscal and monetary management needs to be reoriented with fresh thinking that respects the federal structure of our economy.
Now let us turn to the spending by government. The GoI spends more than two-thirds of its total expenditure on interest payments, defence and subsidies. The first two are hardly developmental in nature. The State governments in the current scenario have limited resources of their own. The resource transfer from the GoI is critical. It is important also to mention here that due to the return of migrant labourers, there are States with surplus labor force and some Sates with a deficit labor force. There is an undercurrent of trust deficit in our federal set-up. This needs to be corrected by mutual discussion with the State governments in the spirit of cooperative fiscal federalism.
To sum up, the situation which will unfold the near future in the post-Covid 19 world is a complete collapse of the economy in terms of growth and livelihoods. This is a true challenge of leadership. In this new world, with the back of the economy broken, fiscal and monetary management needs to be reoriented with fresh thinking that respects the federal structure of our economy. This fresh thinking must include: reorientation and redesign of the MGNERGA and other employment schemes as per the requirements of the States, with a view to revive consumption; designing the expenditure scheme for the health sector in consultation with the State governments; and reorienting the debt management of State governments by introducing a combined borrowing programme for the State and GoI.
(The writer is a former central banker and a faculty member at SPJIMR. Views are personal)