As Fiscal Policy Picks Up The Baton, RBI May Need To Stay Nimble: Sajjid Chinoy
As fiscal policy picks up the baton of reviving the economy and sustaining growth, monetary policy may need to pick between being complementary or a substitute so that “all guns are not blazing at the same time”, according to Sajjid Chinoy, chief India economist at JPMorgan.
The central government’s budget for 2021-22 reflected an increase in spending to support the economy. This showed in a wider-than-expected fiscal deficit of 9.5% for FY21 and 6.8% for FY22. While some of this was on account of higher subsidies and accounting for earlier borrowings by the Food Corporation of India, government spending has risen since the third quarter.
“Expenditure growth — net of subsidies and interest — after a slow start has picked up steam in the second half of the year, with the budget projecting growth of 14.3% this year, such that its ratio to GDP is expected to increase by almost 2% from 8.9% in FY20 to 10.8% in FY21,” Chinoy said in a post-budget report.
In FY22, expenditure (excluding interest and subsidies) will fall to 10.3% of GDP. “This is a withdrawal of some of the Covid-year stimulus, even though this ratio remains much above its 8.1% average of the 3 years pre-Covid,” Chinoy said in his report.
Does this shift in fiscal policy, which provides strong government spending support to the economy, mean that monetary policy can start to pull back after a year in which the central bank cut rates and allowed the system to be flush with liquidity?
Chinoy said their approach will have to be nimble.
In FY21, a positive savings-investment gap, reflected in the rare current account surplus, had allowed higher government borrowings to go through smoothly. In FY22, India will return to a current account deficit of about 1% of GDP, implying lesser private sector savings to absorb the still-elevated borrowings of Rs 12 lakh crore.
There are two implications of this [higher borrowings alongside normalising savings]. One, is that we will have to get used to the fact that equilibrium [bond] yields in the market will have to be higher... Second, the RBI’s near-term focus will have to be that the move to the new equilibrium is non-disruptive and gradual.Sajjid Chinoy, Chief India Economist, JPMorgan
At present, liquidity remains in a large surplus of Rs 5-6 lakh crore. While the central bank has signaled a return to more normal liquidity management, it has started with a small step of resuming variable rate repo operations. That pushed up short-term interest rates.
The question, Chinoy said, is how do you normalise liquidity or how do you avoid adding liquidity while also supporting the government’s borrowing programme to avoid a big jump in yields.
The most obvious approach [to liquidity] would be to separate between stock and flow. There is a large existing stock of liquidity. If you can withdraw that stock, for example, when the cash reserve ratio normalisation happens in March, about Rs 1.5 lakh crore will be withdrawn. That allows the RBI, in the near term, to do Rs 1.5 lakh crore in open market operations such that the total quantum of liquidity doesn’t change.Sajjid Chinoy, Chief India Economist, JPMorgan
An eventual entry into a global bond index would also help bring a new source of demand for government securities, he said.
Budget Strikes The Right Chords
Commenting on the budget, Chinoy said there has been a significant improvement in transparency on the expenditure side as the government. The decision to bring off-budget spending on account of Food Corporation of India onto the government’s balance sheet may have brought on a “sticker shock” in terms of the higher fiscal deficit but is “well worth it”, Chinoy said.
Equally, there has been “welcome conservatism” on the revenue side, which allows for upside in revenue collections in both FY21 and FY22.
Chinoy said there has also been a “conscious effort” in the budget to use public investment as a driver of growth in the next few years. “I think that is exactly the right strategy.”
Over FY21 and FY22, the compound annual growth rate of nominal GDP is about 4.6%, whereas the compound annual growth rate of capital expenditure is 26%. As a share of GDP, capex is going from about 1.6% to almost 2.6% of GDP next year.
I think that is the right strategy because in the current environment where capacity utilisation rates for manufacturing are below 70%, we have to crowd-in private investment push. Only a big public investment push, only the certainty of that demand will crowd in private investment... I think that’s a very clear macro strategy.Sajjid Chinoy, Chief India Economist, JPMorgan
Watch the full conversation with Sajjid Chinoy here: