Budget 2018: Between a (Fiscal) Rock And a (Growth) Hard Place

Budget 2018 will be presented against the backdrop of considerable uncertainty.

Visibility on the government’s finances is low due to the implementation of the Goods and Services Tax. Most economists expect the government to breach the fiscal deficit target of 3.2 percent of GDP in the current fiscal. There is also a question mark on whether the government would stick to its plan to bring down the fiscal deficit to the planned 3 percent of GDP by fiscal 2019.

The Debate About Fiscal Deficit

The fiscal deficit trend over a span of ten years.

Veterans like former RBI governor Bimal Jalan have argued that very strict fiscal targets are counter-productive. For an economy like India, growth and jobs should be a bigger priority, Jalan has argued. Along the way, if the fiscal deficit expands by a few basis points, the government and analysts should not fret.

Not everyone agrees. Fiscal purists feel that sticking to stated targets is critical to the government’s credibility. Bond markets, too, have signaled to the government that it would want fiscal targets to be adhered to. The benchmark 10-year bond yield has risen 100 basis points in the past year. Fiscal concerns have played a large role in this increase in market interest rates.

Senior economists that BloombergQuint spoke to said that sticking to fiscal deficit targets is important in order to maintain overall macroeconomic stability and also from the perspective of inflation management.

Arvind Virmani, former chief economic adviser to the Government of India said that temporary revenue shortfalls, which may have arisen following the implementation of the Goods and Services Tax, should be covered using non-tax revenue sources such as disinvestment proceeds. In the current fiscal year, the government is hoping to raise Rs 72,500 crore through disinvestment.

"There is a hard earned reputation, which takes a long time to build, of sticking to fiscal targets. One should not violate that lightly. If there are temporary shortfalls because of GST, I think there is still sufficient time to increase the equity sales in government companies to meet these shortfalls." - Arvind Virmani, Former Chief Economic Adviser

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In a note dated 19 January, brokerage house Credit Suisse said that it estimates a shortfall of Rs 90,000 crore in receipts in 2017-18. The brokerage house, however, also expects government expenditure to be 3 percent lower than budgeted.

On balance, the fiscal deficit is expected to settle at 3.4 percent in FY18 and 3.2 percent in FY19, said Credit Suisse.

Sudipto Mundle, emeritus professor at the National Institute of Public Finance and Policy, added that fiscal policy should be counter-cyclical. Mundle pointed out that while GST revenue has been declining in the past few months, the government is trying to improve compliance.

“Furthermore, everything else is up. The direct tax revenue has been bouyant. Disinvestment proceeds may overshoot targets. Also surpluses will be generated through public sector enterprises and the RBI,” said Mundle while adding that the government’s decision to pare down its additional borrowing plan from Rs 50,000 crore to Rs 20,000 crore suggests that it has managed to garner resources from other sources.

Both Virmani and Mundle also pointed out that fiscal policy should be counter-cyclical. Since a turnaround in growth in now visible, the need for expansive fiscal policy is not apparent, they said.

"When growth is recovering, I see no reason to compromise on fiscal consolidation. It is very important to send the right signals to the domestic economy and the global economy." - Sudipto Mundle, Emeritus Professor, NIPFP

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Does Growth Need Government Support?

One argument made by those who support an expansion in the fiscal deficit is the sluggish pace of economic growth.

Advance estimates released by the Central Statistical Office suggest that GDP growth in 2017-18 will settle at 6.5 percent, the lowest in four years. However, quarterly GDP data and high frequency indicators suggest that growth bottomed out in the second quarter of the year. Data points, such as the manufacturing PMI, suggest a pick-up in growth in the October-December quarter. A pick-up in bank credit growth, which has risen to 12 percent in January, also suggests some revival in economic activity.

Virmani noted that GDP growth for the full financial year may be marginally higher than the 6.5 percent forecast and settle at near 6.7 percent. GDP growth in the second half is expected to be between 7-7.5 percent, Virmani said while adding that he expects consumption to recover.

"On the investment side too, there is some recovery. And finally, the external environment is strong which should help exports to pick-up over the next 6-12 months."

Mundle sees growth in fiscal 2018 at 6.7 percent, in line with the Reserve Bank of India’s forecast. He, too, expects growth to recover to 7-7.5 percent in the next financial year.

"If you look at the capital expenditure component, after having gone down consistently for 5-6 quarters, it has now been going up for the last two quarters. That is likely to sustain. I am quite hopeful that the capital expenditure problem that has been the main cause of the slowdown is finally turned around. I hope that will sustain given that the external environment is also very helpful." - Sudipto Mundle, Emeritus Professor, NIPFP

The export sector, real estate and farm sector are some areas that economists hope the government will pay special attention to.

While headline growth may recover, the government may still need to think of ways to strengthen certain segments. The export sector, real estate and the farm sector are some areas that economists hope the government will pay special attention to.

While there is a long term issue of productivity in the farm sector that needs to be addressed, in the short term, concerns over the rural economy may be exaggerated, Virmani said. He suggests the government focus on those long-term issues rather than looking for quick-fixes to the perceived rural distress.

“Agriculture is one of those sectors where we have seen no reform, whether in terms of export-import policies or domestic constraints. If we are to get higher productivity and incomes and full-time jobs in rural services and agriculture, then we need to carry out those reforms. This is where the issue of populism comes in - whether they will focus on short-term relief measures and give-aways or will they focus more on these medium-term issues,” he said.

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Mundle, who believes the rural economy is depressed, noted that schemes such as the rural roads scheme, the affordable housing scheme and the employment guarantee scheme are all important to address rural distress. According to him, the government should stay away from loan waivers and focus on existing schemes which aid the rural economy.

“For instance, the Pradhan Mantri Gram Sadak Yojana is one of our most successful infrastructure schemes, it helps improve connectivity to rural areas and is employment intensive. Going down that route helps growth and it brings relief to people. Similarly, the rural employment guarantee scheme is our default welfare system. The government will certainly sustain if not expand spending there,” Mundle said.

A comparison of budget estimates of the central government schemes.

When asked whether the Narendra Modi-led government would be tempted to announce populist measures in its last full Budget before the general elections in 2019, Virmani said some populism is inevitable from all governments. “Every government will do some political things. My margin is 10 percent. As long as it’s not 20-30 percent of the Budget, its not a concern,” he said.

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