Government has enough firepower to spend its way out of recession

Government is needlessly self-shackled.

V Kumaraswamy

The Government looks like a batsman wanting to play only copy book orthodox shots in death overs of a T20 cricket match. The wherewithal and the government’s ability to spend are far better than when we faced sub-5% growth last. Yet the government seems morally shackled and too ideologically paralysed and unaware of its fiscal strengths.

The virtuous looking dogmas that is sustaining the present pall of gloom are (i) that the fiscal deficit targets given are inviolable and the present situation does not call for any counter cyclical action due to shortcomings in FRBM Act or the Review Committee, (ii) the Inflation Targets (4 +/- 2%) developed by the RBI are a kind of moral or constitutional obligation, (iii) better prices mean better welfare for the people and (iv) the masochist pride over currency values – an overvalued currency is a sign of strength.

The assumptions behind false prides attached of currency values and welfare effect of cheaper prices needs to be shed. But here we will see how despite the vastly superior financial fire power at its disposal, the economy is unable to take benefit of it – rather such inaction seems to be the root cause of the problem. The assumptions concerning fiscal and inflation bounds need to be revisited by more pragmatic economists.

First the monolithic way Inflation targets have been prescribed. It will be tough to find in economic history how a fledgling economy trying to graduate from lower income to low middle contained its inflation at 3-4% or those who grew at 7-8% with such low inflation consistently. Any growth will expand demand which will mostly increase the prices while interacting with an upward sloping supply curve. Even if the current excess capacities, will require better prices to restart. There are no flat supply curve commodities especially with people’s growing quality and brand consciousness. The more the demand growth fuelled by growth in economy the more the inflation is likely to be. To prescribe a 4% central rate and follow it up with hysterical reaction even when the economy gets close to it is a sure way of supressing demand. It appears that over the last 3-4 years the low target of 4% has pulled down our growth rate to 4-5%.

No doubt the poor need protection. But when the same poor is borrowing at 3.5% per month and in some daily loan cases that much for a day, to target interest rates’ closest economic cousin inflation at 4% to protect them seems absurd and ill conceived.

Second, the fiscal deficit targets. The dissent note of the former CEA points out several lacunae in the approach and final recommendations of the recent FRBM review Committee. The report is not comprehensive nor does it deal with appropriate counter measures for various contingencies. The 3% wait either ways before Government can act is far too wide and as the ex CEA points both magnifies over heating and further depresses an economy in distress.

The government has to be complemented for the way it has built the Balance Sheet strengths of the economy but the costs it is paying is too much in current terms. Chart 1 calculates the revenue receipts, expenditure and subsidies as a % to GDP for the period 2008-09 to 2018-19 and compares how these % measure up if 2008-09 is the base year.  As can be seen, revenue receipts of the central government have fallen by 5% but the expenditure has fallen by 20% and subsidies by 32%. Even if the fall in subsidies is due to plugging of leakages, it still means contraction of government expenditure going into private hands. Moral issues aside, it will still have its economic impact. The Central Government’s capital expenditure have moved but in narrow range (albeit downwards) and have not compensated for it. Government’s fiscal rectitude has of course brought down the CG’s debt as % to GDP from 56.1% to 47.8% and the fiscal deficit from a high of 6.46% to 3.34% today. It has been commendable but it has also taken its toll.

The difference between the nominal growth rate (g) and the (nominal) interest rates that the government (r) borrows is an important measure of how sustainable the deficits can be, and ‘g’ is most likely higher than ‘r’. The government’s ability to raise taxes is a function of nominal GDP but it has to pay only ‘r’ to sustain such deficits. But as Chart 2 shows despite our great fiscal restraints, this gap has been on continuous decline, reflecting an unexplained inability to use its strength to bring down yields on government securities.

One reason may be the ‘black’ fiscal deficits – amounts parked outside through extra budgetary resources or instruments issued by CG allied institutions which compete for the same kitty as CG’s debt on eligibility criteria and hence are having their impact. And if there are multiple agencies placing essentially the same instrument, the pricing power of the central government takes a beating. Even if in the short run, it may be irksome it may be more prudent to consolidate the black and white fiscal deficits and manage them as one.

Given its enormous strengths the Government should be bold enough to cast aside (at least for sometime) the needless and contextually out-of-sync inflation and fiscal targets and spend its way to revive the economy. The government can as a first measure raise upto 1-2% of GDP and firstly clear all its pending bills (to NHAI contractors, Fertiliser subsidies and capital expenditure payments for railways and defence) that every Govt does to manage fiscal numbers. Since these expenditures have already been incurred in the past most likely there won’t be inflation from these. The balance can be for newer capital expenditure or paying off state GST dues.

I hope the government overcomes academic impositions with practical actions.

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