Hyderabad: Excessive borrowing is negating growth, reorienting expenditure for efficient resource use only option With the economy slowing to 5% this year, perhaps even lower, demands for increased government spending have escalated ahead of the budget scheduled for February 1.
This is the third straight year of growth deceleration since 2017-18 and unlike the slowdown six years ago (2012-13), a 1.8 percentage point drop in real GDP growth, this year extends to consumption. Business spirits are depressed; so are the sentiments of consumers who remain despondent about future income increases.
The pressure upon the government to revive the economy is intense. It is not surprising in this light that many urge fiscal stimulation to manage the downswing. Others argue the opposite, advocating restraint and saying increasing expenditure is not the appropriate solution for the prolonged, deepening downturn that India is suffering.
Can stepping up public spending turnaround the economy, put it on a sustainable uptrend?
There are no easy or unqualified answers. The aggregate economy is the sum of many moving parts, which may not always rise or fall together. While one segment may respond positively to a stimulus, another may pay the price as a result.
Thus, higher allocation for farmers, say, through PM-Kisan scheme, will no doubt put more money in their hands; because poorer segments tend to consume more relative to income than richer ones and their population share is larger in India, aggregate demand or GDP will react positively; ceteris paribus, the increased size of spending will determine the magnitude of response.
Such a rise will however be short-lived without a subsequent response in investment, which leads to employment and income growth to drive consumption thereafter. If we see the enormous rise in current expenditures vis-a-vis falling GDP growth in recent years, the temporary nature of these boosts becomes clear: Central sector schemes, including food, fertilizer and fuel subsidies, PM-Kisan and other farm price support measures, rose 35% year-on-year in FY18 and then 23% last year (FY19), yet growth slowed and consumer spending declined!
Another scenario is that government spends more on building roads, bridges, ports, etc. in which case increased contracts and orders will spur sales of cement, steel, and other building materials, encourage unskilled jobs in construction. Returns on such expenditure typically exceed initial amounts spent because multiple activities respond to the new transport and other possibilities.
This impact is more enduring, explain why boosting investment is favoured over consumption, although such expenditure takes longer to implement compared to welfare or income transfers that are spent immediately. But here too, the recent experience is less than encouraging.
The government invested heavily in infrastructure throughout 2014- 19, escalating this to Rs 4 trillion each in FY18 and FY19, yet real GDP growth slipped to 7.2% (from 8.2% in FY17) and 6.8% respectively with a steeper fall to 5% predicted this year.
These trends are noteworthy and not easily dismissed because if spending policies are not yielding the expected bang from the bucks, they must change approach. The government has limited resources earned from taxes and nontax sources; it cannot infinitely borrow increasing amounts to finance growth as eventually, resources run out and negative effects set in. This is precisely the spot in which the Indian government is now. It has been building up and signs of higher current and capital spending with declining growth are indications.
The red line for the government balance sheet is set by the fiscal deficit, the gap between revenues and expenditures that is closed by borrowings. The revenue position has worsened this year from slower growth and losses from corporate tax cuts. Tax revenues are expected falling short by as much as Rs 2.6-3 trillion; reportedly, direct taxes have fallen for the first time in two decades.
Read more:'Revisiting original FRBM Act key to economic revival'
Non-tax revenues could be short too from delayed divestment of stakes in Bharat Petroleum, Container Corporation of India and Shipping Corporation. The government is reported to attempt recouping such revenues by seeking Rs 100 billion interim dividend from RBI (in addition to Rs 1.5 trillion surplus transfer earlier this year), larger dividends from oil companies and other PSUs, and past dues from telecom companies. This scrambling underlines how cash-strapped the government is.
Nonetheless, the fiscal deficit is expected to enlarge to 3.8-4.1% of GDP against the pre-committed 3.3% this year. This however, does not include undisclosed, off-budget borrowings of government through public entities like NHAI, IRFC, FCI, etc., a route increasingly used in the past to sidestep the official headline deficit constraint to finance expenditures.
So although the government adheres to fiscal law (Fiscal Responsibility and Budget Management Act, 2003) prescribing gradual reduction of deficits and public debt to sustainable levels, the magnitude of off-budget borrowings has escalated.
Total public borrowings are commonly believed around 8.5-9% of GDP, i.e. nearly most of Indian savings. The result is little financial resources left for non-government, private borrowers who face higher interest rates, an adverse outcome described as ‘crowding-out’.
Private demand therefore could be depressed because of excessive government spending! Some advocate recourse to an escape clause recommended by FRBM Review Committee (2017) upto 0.5% of GDP to accommodate a fiscal stimulus, in addition to this year’s slippage. This too would mean further borrowing.
There is also suggestion the government should circumvent FRBM constraints by amending the act and go for growth. This would come at the loss of credibility and market confidence; such action without groundwork to prepare markets, for which there is no time, would be a self-goal.
Moreover, it isn’t just deficits that are troublesome; public debt (centre plus states) too is in a risky territory at 70% of GDP. This is closely watched by investors and rating agencies, who lose confidence and downgrade in case of deterioration.
The question then is if the government should borrow even more for boosting demand. There is no free lunch here - gains on the swing are more than lost on the roundabout. Many private segments of the economy are struggling with indebtedness or unresolved bad loans, be it banks or NBFCs, large corporates or MSMEs, or households; amongst other things, a soft interest rate environment is required for healing and less borrowing by the government can help in this.
The best or only course for government therefore is to restrict itself to balance sheet expenditures alone. It can however, reorient some expenditure items, e.g. reducing/rationalising wasteful subsidy expenses, towards more efficient use to boost demand.
The marked deterioration of public balances closes the door for any ambitious up-scaling of expenditures, calls for modest acceptance of low growth for a while instead.
(Renu Kohli is a New Delhi based Macro-economist. Views expressed above are her own.)
