Faltering GDP growth, a consumption slowdown, a truant monsoon that has already hit kharif sowing, global trade tensions and a freeze in the credit market that has set alarm bells ringing across the financial system. This is the backdrop to the maiden Budget of the Finance Minister, Nirmala Sitharaman.
Walking a tightrope
The Minister has had less than a month to work on this crucial Budget which is expected to work its magic on the economy. Ms. Sitharaman’s position is unenviable. She has to push for growth, which means stimulus measures, but also stay fiscally responsible, which means sticking to the fiscal deficit glide path. This balance is almost impossible to achieve in an environment where tax revenues do not offer enough support for a stimulus package.
The questions before Ms. Sitharaman are simple: Should she opt to stimulate consumption in the economy even if it means putting the fiscal deficit glide path in temporary cold storage? If yes, what is the best way to do that?
Following from the above are subsidiary questions such as these: Will the resultant higher borrowings crowd out the private sector borrowers and push up market interest rates at a time when the monetary authority is driving rates down? What will be the impact on inflation? Should the stimulus be in the form of cutting taxes and putting more money in the hands of the consumer? Or should it be in the form of even higher spending on infrastructure that will have definite fiscal spin-offs? And what about welfare spending? The government has already announced an expansion of the Pradhan Mantri Kisan Samman Nidhi Yojana that will take away ₹87,500 crore this fiscal. And there are many other pet schemes of this government that need to be funded.
To be sure, the answers are not easy. But just consider these. GDP growth fell to 5.8% in the fourth quarter of 2018-19, with important industry segments reporting a fall in growth. Sales of automobiles , the bellwether for the larger economy, has been sliding since October last year and in the first quarter of this fiscal, sales volumes are down by about 18%. Fast moving consumer goods, two-wheeler and consumer durables manufacturers are all reporting dull rural sales.
Real estate and construction, one of the biggest job creators in the economy, have been in stupor for several months and are a direct cause of the credit freeze in the markets now. It is clear that the bottom has fallen off consumption demand, something reflected in the annual results of a host of companies in the consumer sector.
Given these, there is little doubt that the economy needs a stimulus. The downside to the government embarking on this path is clear. Direct tax revenue growth failed to meet budgeted levels in 2018-19, falling short by ₹82,000 crore from the target of ₹12 lakh crore. Goods and Services tax collections, though rising, are still not stabilising at the required level of between ₹1,00,000 and ₹1,10,000 crore a month.
It will be next to impossible for the government to meet its over-ambitious tax estimates in the interim Budget for 2019-20. And then there are the bills to pay from last year to the Food Corporation of India and a couple of other public sector undertakings which helped the government ‘achieve’ the fiscal deficit target last year.
Pros and cons of options
There are a few options that the government can consider for off-balance sheet financing. First, go big on asset sales. The interim Budget had earmarked ₹90,000 crore from disinvestment but if the government is able to successfully pull off the Air India sale, it would be almost half-way there. There are a host of other government companies that can be sold off to raise the targeted proceeds.
Second, a one-time transfer from the Reserve Bank of India’s reserves , which is under the consideration of the Bimal Jalan Committee. However, if reports of the committee’s deliberations are to be believed, it may be futile for the government to hope for a major windfall here. The committee will anyway submit its report well after the Budget is presented.
Third, 5G spectrum auctions . While there is reason to hope for some support here, it is unlikely that it would materialise this fiscal. The telecom companies are still licking their wounds from the combined effect of past excesses and bruising competition in the market. Their appetite, as it is, is poor for any more spectrum. So pushing through a 5G auction now would be disastrous.
That leaves us with just one option — that of increasing borrowings which will, of course, mean curtains for the fiscal deficit target of 3.4% this fiscal. Higher government borrowings may elbow the private sector borrowers out.
Increased borrowings by the government will have the unintended negative consequence of pushing up market rates which is something that the government would not desire. And then, of course, there will be questions to answer from Standard & Poors and Moody’s which are certain to take a dim view of the fiscal indiscretion.
But then there is some good news too. Thanks to the recent directive of the stock market regulator, the Securities and Exchange Board of India directing mutual funds to put away 20% of their liquid scheme investments in government securities, a new market opens up for the government. Whether it is deep enough to absorb the increased borrowings is a matter of detail but it can certainly cushion the market to some extent.
Second, yields on government securities are at around 6.82% currently. So even a 10 or 20 basis point rise due to higher borrowings may not cause much dissonance. The market is aware of the difficult circumstances now and should be able to take this in its stride.
As for the ratings agencies, the government needs to be in dialogue with them, reiterate its commitment to fiscal discipline and reassure them that this is a temporary aberration.
So, once the decision is made to be accommodative, Ms. Sitharaman’s problem will be to identify the best way to impart stimulus. There are two choices — either to cut taxes and let consumers to go out and spend the excess. Or just borrow and spend on asset creation in infrastructure. Given that there is a serious slowdown in consumer-facing sectors, the better option may be to put more money in the hands of consumers.
A good option to consider would be adjusting income tax slabs and increasing deductions under Section 80C which is a measly ₹2 lakh now. Better still would be to increase the interest deduction for housing loans which would also give a boost to the real estate market. These measures would run counter to the reform objective of easing out all exemptions and lowering rates. But then that is under examination by the Direct Tax Code (DTC) panel; the concessions given now will automatically become a temporary measure assuming that the DTC is soon implemented.
The fall in tax revenues from the concessions will be eventually made up downstream from indirect taxes if consumers spend the extra money in their hands. The choice to borrow and spend is indeed a difficult one but in the current circumstances this may be inevitable. Fiscal conservatives are bound to frown at this and there would be dire warnings of the consequences of not adhering to the fiscal deficit commitment. The best answer is that this government now has five years to make up for the indulgence. Will Ms. Sitharaman go the whole way?