NEW DELHI – In order to achieve its medium-term fiscal consolidation aim of below 4.5% of GDP by 2025-26 (Apr-Mar), the government needs to increase the tax buoyancy since compression of expenditure would hurt economic growth, says Lekha S. Chakraborty, a professor at the National Institute of Public Finance and Policy.
"In the post-pandemic fiscal strategy, reducing revenue expenditure is detrimental. Given the inflation and low growth recovery, fiscal policy needs to remain accommodative," Chakraborty told Informist in an e-mail interview.
"Keeping Status Quo On Rates (in April Meeting) Is Crucial For Pre-empting Global Recession," Chakraborty Says
To reach a sub-4.5% fiscal deficit, the government will have to lower it by at least 140 basis points in the coming two years from the projected 5.9% in 2023-24. In comparison, fiscal deficit is seen declining by just 80 bps in 2022-23 and 2023-24 combined, despite relatively favourable nominal GDP growth.
Talking about the increase in government's market borrowing in a high interest rate environment, Chakraborty says that debt consolidation by shaving off expenditure poses downside risks against the backdrop of macroeconomic uncertainties and geopolitical risks.
The government's gross market borrowing is projected to touch a record-high of 15.43 trln rupees in 2023-24.
At the heart of a high interest environment is the 250 basis points increase in repo rate by the Reserve Bank of India since May last year.
"Keeping status quo on rates (in April meeting) is crucial for pre-empting global recession," she says. "High interest rates affect the economic growth recovery process."
Below are edited excerpts from the interview:
Q. The government is committed to lowering fiscal deficit to less than 4.5% by 2025-26 (Apr-Mar). Given that we are ahead of an election year, how difficult do you think that will be?
A. Tax buoyancy will be crucial for lowering the fiscal deficit to medium-term fiscal consolidation path by 2025-26. However, if the lowering of fiscal deficit is through public expenditure compression, it will have adverse economic growth consequences. In the post-pandemic fiscal strategy, reducing revenue expenditure is detrimental. Given the inflation and low growth recovery, fiscal policy needs to remain accommodative. The political economy of fiscal deficit is compelling against the backdrop of elections. However, ensuring food security, strengthening social infrastructural investment, ensuring targeted social security measures, and 'employer of last resort' policies by the government will be relatively more effective than designing clientele-based public spending (freebies).
Q. The government's market borrowing has almost tripled over the last five years – it is projected to touch 15.43 trln rupees in the year starting April from 5.71 trln rupees in 2018-19. Do you see any real likelihood of debt consolidation?
A. Public debt management in a high interest rate regime is a tough call. High public debt can be substantiated to a certain extent if it is linked to capital expenditure infrastructure investment. However, if interest payments to revenue receipts ratio crosses a threshold of 25%, what is available for developmental expenditure will shrink. If real interest rate does not cross real rate of growth, we can grow out of debt. Debt consolidation through fiscal austerity measures by curtailing crucial public expenditure will be detrimental to the economy, given the macroeconomic uncertainties and geopolitical risks. A simultaneous selling of short-term bonds and buying of long-term bonds can elongate the refinancing strategic path and postpone the refinancing risks. This strategy in debt maturity structure will help India to have fiscal space to be on a robust growth path.
Q. India's tax collections have been extremely robust in the last two years, even surpassing the nominal GDP growth. Do you see this trend continuing in the current financial year?
A. Tax buoyancy - the responsiveness of taxes to increase in GDP - is relatively better. In the context of an emerging economy like India, tax administration is tax policy. Tax reforms are crucial to ensure sustained tax collections. Increasing tax rates to augment revenue may affect competitiveness and that cannot be an ideal solution in post-pandemic strategy. We need to co-read these developments against the backdrop of international taxation reforms as well.
On the indirect taxation front, multiplicity of rates is a dampener. Rationalisation of rates is a significant determinant for prolonged tax buoyancy. How to effectively bring in natural resource taxation within the intergovernmental fiscal transfers is yet another crucial area of concern, and I hope the 16th Finance Commission will have deliberations on this.
Q. Finance Minister Nirmala Sitharaman has said that India Inc is not investing enough even though the central government has made policy changes and has substantially increased its capex, where do you think the problem lies? What is stopping them?
A. Public capex infrastructure is a significant determinant to "crowd-in" private corporate investment. However, this phenomenon of attracting one dollar increase in private investment to one dollar increase in public investment is not instantaneous. The lags in the process need an analysis to understand the macroeconomic determinants of private investment. The macroeconomic fundamentals need to be strong to attract investor confidence. Given the geopolitical risks and uncertainties, financing of private investment is in doldrums. The interest rate dynamics play a crucial role here. The central banks going hawkish across the globe makes the investment process costly and entrepreneurs finding ways to re-switch the modes of financing private investment.
Q. What is India's potential growth? Do you think the country's medium-term growth potential has fallen below 7% from 8-9% seen till 2016-17?
A. It is tricky to predict "potential growth" based on high frequency data. It is a no-brainer that the "output gap" - the gap between potential and actual growth - is a controversial concept. This is because "dating" the existence of business cycles is tricky when the drop in GDP from prior-crisis level is not cyclical but leaves "permanent scars". Having said that, I have quarrel with the way fiscal and monetary policies are designed as "counter-cyclical" policy tools. The medium-term growth potential depends on fiscal and monetary policy coordination in an open-economy model framework.
Q. The Reserve Bank of India has projected India's annual average inflation to decline to 5.2% from 6.7% last year. Given that crude oil prices remain elevated and demand is likely to pick up, do you think the reduction is possible?
A. Of course, oil prices enter the RBI inflation forecasting models. It is a crucial variable. There is a high probability of forecasting errors in inflation projections, emanating from energy price volatility. How the RBI can anchor "expectations" from supply side shocks through inflation targeting is an empirical question.
Q. Do you think the RBI has been behind the curve on raising rates?
A. I don't think so. "Which curve" is what Monetary Policy Committee members always ask when this question is posed to them. The RBI has reversed the sequence of priority from growth to mounting inflation. Continuous raising of interest rates to tackle capital flight, mounting inflation, and financialisation of savings is indeed welcome. This pause in interest rates at the April MPC meeting should be treated just as a "pause" not a "peak" rate. I don't have any specific knowledge if 6.5% is the "terminal" rate. The "liquidity guidance" by RBI along with manoeuvrings of policy rate is crucial.
Q. There has been some criticism about RBI looking at the 2-6% inflation range rather than the target of 4%. Do you think it is a fair criticism?
A. Of course the nominal anchor of inflation in India is 4%. We need to reach 4% to pre-empt a prolonged negative interest rate regime. The + or - 2 band has become business as usual rather than an exception. This is dangerous as it leads to reputation risk of central bank authorities.
Q. With the Monetary Policy Committee leaving rates unchanged, do you see a prolonged pause now?
A. Keeping status quo on rates is crucial for pre-empting global recession. High interest rates affect the economic growth recovery process. However, if the US Federal Reserve puts pressure on central banks in emerging economies, it is natural that we respond with interest rate defence to tackle flight of capital. This is the policy dilemma of RBI. End
Edited by Ashish Shirke.
This is first published in Informist, Friday, Apr 28, 2023.
Priyasmita Guha is Correspondent @InformistMedia. Lekha Chakraborty is Professor, NIPFP and Research Associate of Levy Economics Institute of Bard College, New York and Member, Governing Board of International Institute of Public Finance (IIPF) Munich.)
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.