Budget 2020: FY21 Fiscal Target Will Be Difficult To Meet, Says Former RBI Governor C Rangarajan
Dr C Rangarajan, former governor of Reserve Bank of India. (Photographer: Namas Bhojani/Bloomberg News)

Budget 2020: FY21 Fiscal Target Will Be Difficult To Meet, Says Former RBI Governor C Rangarajan

The government has set a fiscal deficit target of 3.5 percent for the financial year 2020-21, narrower than the now 3.8 percent fiscal gap for the ongoing financial year. This target will be difficult to meet, according to C Rangarajan.

“The next year’s fiscal deficit target of 3.5 percent, which on the face of it is very acceptable, but the big question is whether it will stick,” Rangarajan, former governor of the Reserve Bank of India, told BloombergQuint.

The reason for doubt partly stems from the earlier lower-than-estimated nominal gross domestic product growth of 10 percent and the projected growth of tax revenue at 12 percent. “It’s a buoyancy of greater than one, which we have not seen in the last two years,” he said.

The larger reason for doubt is the non-tax revenue, particularly the government’s divestment target.

It’s fixed at a very high level. Therefore, we may end up next year as well with a fiscal deficit of 3.8 percent.
C Rangarajan, Former Governor, Reserve Bank of India

Finance Minister Nirmala Sitharaman, in her second budget speech, announced a fiscal gap of 3.8 percent for the current financial year, which was along expected lines. She also announced a lofty disinvestment target of Rs 2.1 lakh crore for the next financial year. Of this, it expects to earn Rs 90,000 crore by selling stake in public sector banks and financial institutions, while the balance Rs 1.2 lakh crore will come by selling stake in central public sector enterprises.

Also read: Budget 2020: India To Take LIC Public 

Heed Caution Against Monetising The Fiscal Deficit

Rangarajan cautioned against the possibility of the Reserve Bank of India entering the primary bond market.

The problem would be two-fold, he said. “One is that by the RBI coming into the primary market, means actually monetising the fiscal deficit. Second is that whether the coming in of the RBI was expected to lower the interest rate as well.”

I hope we don’t go back to that. I would certainly caution the government on that.
C Rangarajan, Former Governor, Reserve Bank of India

The government today decided to invoke the ‘escape clause’ provided for in 2018 amendments to the Fiscal Responsibility and Budget Management Act, which allows for the government to breach its fiscal deficit target by 0.5 percentage points at times of severe stress in the economy. Invocation of this clause also allows the Reserve Bank of India to buy government bonds directly via primary auctions, a practice that was done away with during Rangarajan’s term at the central bank.

The former governor also disagrees on the basic interpretation of the escape clause, he said. “I would interpret it to say 0.5 percent above the mandate of 3 percent of GDP,” he said, instead of the 0.5 percent deviation from the target indicated in the budget.

Watch | C Rangarajan On The Implications Of Budget 2020 On The Indian Economy

Here are the edited excerpts:

Let me first ask you for an overview of what you made of the budget. The attention as usual, or likely more this time round, is on the fiscal slippage that the government has had to finally give into.

Well the fiscal deficit as they have indicated appears to be reasonable.

One had expected the fiscal deficit to rise from the budget level in the current year because the revenue shortfall has been very severe. The next year’s fiscal target of 3.5 percent on the face of it is very acceptable. But the big question is: will it stick?

The expected national income growth is about 10 percent and the revenue projections i.e. gross tax revenue is expected to grow at 12 percent. So, it’s a buoyancy of greater than one, which we have not seen in the last two years. So, it’s a matter of some concern whether the gross tax revenue will rise this much. But it is not too far off from what one can expect. But what is a very high level of fixing is the non-tax revenue and more particularly, the disinvestment proceeds in the next year. It’s fixed at a very high level. Probably, we may end up next year also with a fiscal deficit of 3.8 percent.

The whole question on the budget is whether a) it will push up the demand? b) whether it will increase the level of investment? The first question much depends on the level of expenditure. As I see very quickly that the increase in the total expenditure is expected to be the order of 13 percent. This is very doubtful whether this will push the demand that much.

I would have expected a little more focus on expenditures because the finance minister went on for more than an hour, explaining various expenditure items and not very sure what that increase is, and how much is the increase over the previous year is.

“Therefore, it’s not very clear on the face of it whether an increase expenditure will really push up either the rural or urban demand.”

For example, even the changes in the personal income tax- may not have much effect on demand because many of the taxpayers even within the income group, which is supposed to benefit, may not fully benefit. I think the contractions are not very strong. In any case, I am not arguing for any big change in the personal income tax; but the point really is, I am somewhat doubtful whether the increase in expenditure will push up the demand.

On the investment side, my concern is that the capital expenditure of the government of India still stands at 1.8 percent of the GDP. It was originally intended to be at 1.6 percent of the GDP last year. Therefore, it remains more or less the same range. Therefore, much of it will depend on whether the private entrepreneurs -- both including companies -- will take some measures that have been introduced as favourable to them and therefore, they will begin to act in terms of the investing.

Perhaps, there could be a greater inflow of funds from outside into India for investment purposes. Perhaps the distribution dividend tax -- the removal of it -- may help the foreign companies much more than the domestic companies. Therefore, that could actually be a reason for a greater inflow of funds into the country. So, on the whole, if you ask me, the budget is well-intentioned. Perhaps a greater focus on expenditures might have been in order. The fiscal deficits are likely to go beyond 3.5 percent of the GDP.

Allow me to ask you a few specific questions.One is, on this decision to invoke the escape clause, which was provided by the FRBM review committee, actually linked to an independent fiscal council. We don’t have the fiscal council; this escape clause has been invoked and there was a slightly worrying provision in the 2018 amendments of the FRBM act which allowed the Reserve Bank of India to buy bonds in primary auctions. Should the escape clause be invoked? We are all hoping it doesn’t go in that direction,I’m sure you would caution against it given the history of deficit monetisation that RBI has come through- a difficult history.

I think so. I personally think that when they went from 3.3 to 3.8, even though the finance minister mentioned that, I hope they are not invoking this particular provision which is also created with the escape clause.  And I also do not think that the escape route permits the government of India to add 0.5 to whatever level they have indicated in the budget. I interpreted them to say only 3.5 percent and above, but the implicit mandate of 3 percent of the GDP. Yes, it would be a worry if they really invoke that provision and request the Reserve Bank of India to come into the primary market. The problem would be two-fold. One is that, by the Reserve Bank of India coming into the market, it means monetising the fiscal deficit. Second is whether the coming in of the Reserve Bank of India was expected to lower the rate of interest as well. So, in any case, they moved away. It was during my time that the Reserve Bank and the Government of India moved into a new arrangement under which the whole system was insured and the whole system of preferables was abolished. I hope we don’t go back to that.I certainly would caution the government on that.

For now, the budget document seems to be suggesting that the incremental gross borrowing that will come due to the higher fiscal deficit, is coming through the National Small Savings Fund. The budgeted borrowing for both a FY20 and FY21 is at 2.4 lakh crore. Even that is not an easy option, wouldn’t you say? Because it does lend to the stickiness of interest rates in the economy if the government has an incentive to keep borrowing and hence keep ensuring that money is flowing into the small savings fund.

I do think that if the government means seriously about lowering the interest rate, then they should really bring down the small-saving range. I think the government cannot,on one hand, talk to the Reserve Bank of India and say, it would be better to bring down the repo rate and on the other, stay with higher rates on small savings. Independent of any other consideration, I would think that, if in general, the government feels that the rates of interest should be lower, then they should really act and bring about a reduction in the small savings rate also.

We didn’t see any large package for NBFCs, given the stress there. Perhaps that’s just as well because it may not be in the purview of the budget. We did see an attempt to revive confidence of bank depositors by raising the level of deposit insurance to 5 lakh. That is a substantial increase. Just in terms of sentiment, a little bit of comfort. Do you think that’s okay to have done?

It is okay to have been done but this does not fundamentally answer the problem. The fundamental problem was that, the people were worried about the fact that they are keeping deposits in the banking system and how safe they are. The finance minister made the statement in this connection saying that, the monetary system is good and therefore, it would ensure the safety of all commercial banks. That’s what she said. Therefore, ultimately the question that is being asked, is whether the banks will ever close down at all. The whole question arises only when a bank closes down. At that point, will the deposits be lost? So far, the Reserve Bank of India has managed it in such a way that no scheduled, commercial banks really fail. When they have a difficulty, some kind of a merger or some arrangements are made that will help to overcome the problem. Therefore, it is not the guarantee of the deposit insurance mechanism that is going to reassure the people. What will reassure the people is much more what the regulatory system and what the monetary system is going to be.

You mentioned divestments. Very heavy divestment receipts being budgeted for.Within that, it is an attempt to take LIC public. Firstly, do you think it’s advisable? Secondly, it would be tough to do as LIC is considered to be a little bit of a black box in the Indian economy.

On the whole, I think LIC has been doing well and after all, there is no given market price and so on and so forth. Therefore, they might be able to do that. But I think the important thing is that the government is really skirting the issue. I mean, the problem is really to address the other public sector enterprises which are in the manufacturing and other areas where should be doing things. They have failed to accomplish that and this year there had been a very severe shortfall. Therefore, they are taking an easy way out and since LIC has been showing profits and so on and so forth, they might be able to divest a little bit very easily and perhaps achieve the target. But I think this is not really disinvestment in the true sense of the term because the idea of disinvestment is really to bring about change in the management, bring about change in the way the companies are being run and so on. That will not happen, I think the LIC will be functioning like they did before and therefore, they are not biting the issue of disinvestment.

There’s a place in the financial market section where they talk about the fact that certain specified categories of government securities would be fully opened upto non-resident investors and then, they of course go on to say that the FPI limited corporate bonds would be raised to 15 percent. There seems to be an attempt to open the capital account a little bit more. Would we start to more and more run into the impossible trinity? Should we be looking at drawing in more and more overseas financial savings to fill the gap that we have here domestically?

All kinds of foreign inflows, debt instruments-whether it is government, or corporate - are either way of financing the investment government savings. That is the way you have to look at it.Therefore, allowing the foreign segment to invest in companies in rupee terms,is not a bad idea because I think the exchange is more by the outsiders. There is a greater risk in terms of sovereign bonds, and I would not advocate that at all. But in the case of foreigners, investing in government securities denominated in rupees, the foreign exchange is more by the foreigners and therefore, some amount of investment in government can be permitted.

But you would advise that caution be exercised, because there’s been a lot of talk about listing on global bond indices. These bonded indices are typically require far greater limits of FPI investment than we have currently, which is 6 percent. If the government is attempting a listing on the global bond indices, steps have to be taken cautiously you would say?

Yes, it has to be done cautiously. I mean, we did permit it even in my time and we kept it more or less at the same level. I think the idea should not be that the easy accessibility of funds should be the circulating factor for incurring larger deficits. This is not the way it should be, and I would say that there is a need for exercising caution but the avenue should not be closed. The avenue should be open.

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