Budget 2020 Ideas For Growth: Overhauling Revenue ExpenditureBloombergQuintOpinion
There is no easy route to recover output on a sustained basis, hard decisions must be taken.
In 2019-20, the Indian economy faces a slowdown comparable to 2012-13. The output drop is of similar magnitude; real GDP is anticipated slowing to 5 percent, a 3.2 percentage point fall from its 2016-17 peak. Another similarity is that the deceleration is continuous and three-years long, notwithstanding the sustained public investment. The stark difference between 2012-13 and now is the absence of an external shock. The government is now running short of ways to fight the downturn. Monetary policy was eased 135 basis points last year but transmission has been erratic and slow. If the downturn were to deepen, it is unclear if monetary policy would have further space because of fresh uncertainties in the inflation outlook. Fiscal policy, recourse to which was limited even last year, has no space to manage the downswing that has taken a toll upon tax revenues.
There is also the need to supplement monetary policy, which is not having the intended effect of encouraging additional spending so far. As the government frames fiscal policy for 2020-21, how can it deal with the downturn?
Fiscal policy choices are never easy in the best of political economy contexts. When times are difficult, as now, tough decisions become near-impossible to take.
Pressures intensify as people expect assuaging responses, which the government must weigh against credibility, market confidence and taking the right economic decisions that typically involve tradeoffs between short-term pain and longer-run gains.
India’s macroeconomic settings are poised precisely at such a crossroad, as budget day approaches.
The Immediate Toolkit
For immediate demand support, urged by many, the only way is to increase current expenditure, notably through MGNREGA and farmers’ income-support with the PM-Kisan scheme. By comparison, public capex takes longer to stimulate. However, resources are a stumbling block. These have shrunk for many reasons, notably the enormous shortfalls in gross tax revenues—estimated between Rs 2.6-3 lakh crore or 1.25-1.4 percent of GDP—and non-tax revenues from divestment due to delayed or slow progress in asset sales. Statistical shocks such as slower nominal GDP growth have added to this.
Fiscal slippage is not only inevitable but also likely to be large, notwithstanding help from some expenditure cuts, deferment of subsidy payments and off-budget borrowings. Combining all this with recourse to the escape clause recommended by the FRBM Review Committee in 2017 would allow a deviation of just 0.5 percent of GDP; this may not just be swallowed by the revenue-expenditure gap, but also lacks the punch required for a meaningful uplift. Finally, in the extreme case scenario, the government could amend the FRBM Act, and revise fiscal targets and consolidation path. But it would then have to reckon with adverse fallouts, the loss of credibility and market confidence. Markets are not prepared for this eventuality and the time is too short for embarking on necessary groundwork.
The Medicine Isn’t Working
The other option is to take a long-term view on repeated growth downfalls since 2012-13 and respond accordingly. The central government alone invested Rs 4 lakh crore on infrastructure in each of the last two years, yet real GDP decelerated.
Government dissaving, officially disclosed and hidden, is estimated in the region of 8.5-9 percent of GDP.
The massive diversion from the surplus sectors is visible in the 10-year bond yield that refuses to soften despite low inflation, monetary easing, and central bank intervention. There is ample evidence of counterproductive, crowding-out pressures suppressing the investment multiplier.
It would be prudent to note these trends and adopt a medium-term, sustainable path to economic revival. This entails taking hard, unpopular decisions.
It would be realistic for the government to admit upfront that the economy’s potential is low, the cyclical gap is small and that growth retardation is structural. To address this, structural fiscal responses are necessary. A long-overdue structural reform, that of public expenditure overhaul, is needed for efficient utilisation of the meagre resources. Public policy discourse, which consistently advocates more structural reforms, has paid no attention to this side of the government balance sheet.
There is a compelling case for expenditure rationalisation, where the focus now must be.
Deterioration in public spending quality has been rapid, and of significant magnitude in recent years. Consider the broad-brush picture since 2016-17:
- A steady rise in revenue expenditure from 11.1 percent to 11.6 percent of GDP in 2019-20.
- Corresponding falls in capital spending – from 1.9 percent to 1.6 percent of GDP – that is increasingly pushed off-budget with adverse knock-on effects noted above.
Much of this worsening arises from mounting subsidies, income and welfare transfers. Central sector schemes—including major subsidies of food, fertiliser, and fuel—accounted for 23 percent of total revenue expenditure in 2019-20, up from 18 percent two years ago, that is 2017-18. Annual increases were a respective 35 percent and 23 percent in the two interval years. The largest push in this period came from the food subsidy (147 percent increase), followed by LPG (125 percent rise) and fertiliser subsidies (20 percent). Farm-income support (PM-Kisan - Rs 75,000 crore in 2019-20 from Rs 20,000 crore the previous year) added to this bloating.
These magnitudes are not small, spent on perpetuating inefficiencies in the management of food stocks and supplies, and are simply unsustainable, besides being growth negative. Social spending and food security are laudable objectives, but such spending commitments must be sustained via revenue generation, not through market borrowings as is increasingly the case. For then, the negative externalities outweigh gains in the overall macroeconomic context with collateral damages to growth, as described above.
The Way Out
Switching expenditures from current to capital spending, with limited manoeuvring of current expenditure to accommodate counter-cyclical demand support, can be considered. A graduated pruning of revenue expenditure needs to be done to release resources for better utilisation and greater demand impact. Perhaps the government can start modestly by lowering the food subsidy bill through either reducing the number of eligible beneficiaries, or quantities of rice and/or wheat supplied under the food security program, and/or increasing the issue/subsidised prices. The pinch can be eased by phased reduction to an eventual 0.3-0.4 percent of GDP over five years perhaps. It is a tough political choice, but broader growth concerns and potential benefits should outweigh political economy considerations.
Improving expenditure quality and restricting capex to the budget will have salubrious externalities. It will release financial resources for the private non-financial corporate sector, ease borrowing costs and enhance the efficacy of monetary policy. It will also boost the capex multiplier whose aggregate demand effects have not been fully observed in the past. There are no easy options left any more.
Renu Kohli is a New Delhi-based macro-economist.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.