After impressive fiscal restraint, it is time to boost potential growth, notes Sajjid Chinoy
It’s easy to get lost in the weeds.
For an economy burdened under the weight of adverse growth-inflation dynamics, it’s easy to get disappointed.
There was hope in some quarters that the interim Budget would boost sentiment and lay the groundwork for kick-starting the investment cycle, while staying on a path of fiscal consolidation.
Such hopes were always unrealistic.
For starters, any vote-on-account is constrained in its scale and scope and avoids big-bang direct tax changes and policy reforms.
So industry can always quibble that ‘enough wasn’t done.’
Others will worry that the excise duty cuts -- while boosting demand -- put even more pressure on flagging tax collections, and further imperil next year’s consolidation.
Yet, others will bemoan the quality of the fiscal adjustment -- an issue we address below.
But while each of these may be legitimate concerns, collectively they miss the bigger picture.
Six months ago, India was the poster-child of emerging market vulnerability.
The current account deficit was an unsustainable five per cent of gross domestic product, the rupee was falling like a stone, the Reserve Bank of India had hiked rates by 300 basis points to prop up the rupee and capital market sentiment had plunged.
With growth -- and, therefore, tax collections -- bound to suffer and subsidies under pressure from the 15 per cent currency depreciation, almost nobody imagined a fiscal deficit even close to five per cent of GDP, let alone 4.6 per cent.
Not a day went by without mention of a sovereign ratings downgrade.
As it turns out, for the first time in 28 years, GDP growth is on course to print below five per cent for a second successive year.
The fact that, in this adverse macroeconomic environment, and with general elections approaching, the finance minister has been able to meet -- and beat -- his target for each of the last two years, needs to be commended. On a cyclically-adjusted basis, the total consolidation over the last two years is a substantial 1.1 per cent of GDP.
This is admirable fiscal restraint in a challenging environment.
More generally, the fiscal adjustment has been crucial to restoring macroeconomic stability in India.
Unlike South Africa and Turkey -- India’s emerging market peers -- India’s current account deficit is expected to print at two per cent of GDP, less than half its level of 4.7 per cent of GDP last year.
Much of this is because of the curb on gold imports.
But some of this is undoubtedly because the current account’s evil twin -- the fiscal deficit -- has been consolidated.
India’s twin deficits are now seen as the most visible manifestations of the macroeconomic adjustment and there is no more loose talk about a ratings downgrade.
Consequently, the rupee is among the best-performing currencies since the taper began. So let’s ascribe credit where it’s due.
But with emerging markets expected to be under sustained stress as the US Federal Reserve normalises monetary policy, one cannot sit back on laurels.
And while the fiscal consolidation of the last two years is laudable, reaching three per cent of GDP by FY17 -- under the fiscal road map -- will not be sustainable unless we see genuine fiscal reform going forward.
In fact, the pressures are likely to rise next year. The finance minister has pegged next year’s deficit at 4.1 per cent of GDP -- a 0.5 per cent of GDP consolidation over the next year. These numbers are not binding.
The full Budget in July can alter these estimates.
But the math currently laid out illustrates the magnitude of the challenge.
To get to next year’s deficit, tax revenues -- which grew less than 12 per cent this year -- will have to grow at a whopping 19 per cent.
And this despite the excise duty cuts in consumer durables and capital goods.
Similarly, miscellaneous capital receipts, mainly from disinvestment, have been only Rs 25,000 crore (Rs 250 billion) in each of the last two years.
Yet, next year they are budgeted at a whopping Rs 57,000 crore (Rs 570 billion).
Finally, subsidies have been budgeted at almost the same level as this year’s outturn.
But with food subsidies sure to surge under the Right to Food Security, one will have to see appreciable rationalisation of LPG, kerosene and urea prices -- apart from the ongoing diesel price increases -- to stay close to subsidy targets.
The bottom line is that next year’s consolidation looks challenging, barring a sharp upturn in growth.
All this underscores a more fundamental point -- that further consolidation cannot rely on pushing out Plan expenditures, running up arrears on subsidies, and squeezing public-sector enterprises. We need genuine fiscal reforms -- the long-overdue goods and services tax that truly makes India a common market and promotes allocative efficiency, and extending Aadhaar to all subsidies -- so that, even without cash transfers, the de-duplication benefits of eliminating ghost beneficiaries can accrue.
Without these reforms, it’s hard to envision sustained fiscal consolidation.
But the challenge for the new government -- of whatever political hue – is even greater: to boost potential growth.
The reason GDP growth is below five per cent but core consumer price index inflation is above eight per cent is simple -- India’s potential growth has fallen markedly in recent years.
And it’s not hard to see why. India’s corporate investment rate -- which reached a high of 17 per cent of GDP in the pre-Lehman year -- has collapsed to nine per cent of GDP.
The reasons are well known: land acquisition bottlenecks, project clearances, coal linkages, raw material availability.
To its credit, the government has jump-started project approvals over the last year.
But we need to up the ante.
The government has to mount an all-out war on implementation bottlenecks, bureaucratic risk aversion and regulatory uncertainty.
And what we need is a comprehensive and quick resolution of the debt overhang on infrastructure balance sheets, and the associated stress on bank balance sheets.
Only then will the investment cycle revive. And only then will potential growth rise again.
The challenge is daunting.
But not impossible.
Because, as the fisc over the last two years has demonstrated, when policymakers truly put the weight of their resolve behind an outcome, they find a way or make one.
Sajjid Chinoy is Chief India Economist, JP Morgan
