India’s policymakers deserve enormous credit. At a time when growth impulses are patchy and uneven, a large Pay Commission award is looming, the stock market is clamouring for more bank recapitalisation funds, and back-to-back droughts have increased pressures to reflate the rural economy, it must have been enormously tempting to unleash an array of spending under the guise of a “growth budget”. Instead, they wisely eschewed playing to the gallery and presented a serious, sober budget that, at its heart, prioritises fiscal consolidation. In other words, they have chosen to protect India’s most treasured asset — macroeconomic stability — in a year that promises to reverberate with alarmingly regular shocks, whether emanating from Beijing or DC. Cricket aficionados will recognise that a batsman’s mettle is often judged more by the deliveries he chooses to let go outside the off stump than the ones he is tempted to play. Well left, Mr Finance Minister.
The dogged fiscal consolidation that the finance minister and his predecessor have engaged in since 2012 has often not been pretty. But it has been critical for restoring macroeconomic stability over the last three years by reducing aggregate demand and, thereby, reining in both inflation and the current account deficit. Yes, of course, India has been helped enormously by the collapse in oil prices that has imparted a massive positive terms-of-trade shock to the economy. But India’s macros began to improve meaningfully well before oil and commodities collapsed, as fiscal and monetary policy became orthodox again.
Policy credibility is a precious commodity in these turbulent global times. So that would have been reason enough to stick to the fiscal path previously promised. But that apart, there are hard-nosed practical reasons to have been fiscally prudent at the Centre. First, state finances are likely to come under pressure next fiscal as they implement their own pay commissions and are liable for interest on Uday bonds. So, even as the Central deficit has been reduced from 3.9 to 3.5 per cent of the GDP, the consolidated deficit of the Centre and the states is likely to be flat compared to last year. Slowing the pace of consolidation would have resulted in an expansionary consolidated fiscal stance. For bond markets, which have seen an unrelenting sell-off over the last three months, with spreads of state bond yields more than doubled, symptomatic of the demand-supply mismatch, a greater-than-expected supply of Central and state bonds may have been the straw that broke the camel’s back. Unsurprisingly, bond markets cheered lustily. Rates rallied across the yield curve, reflecting fiscal prudence and the increased space that this may open up for monetary easing. All this should put downward pressure on borrowing costs for the private sector and help with stressed balance sheets.
So how did the government achieve the consolidation given the aforementioned expenditure demands? I have previously argued that the only way to reduce the deficit in the near term without imparting a drag on the economy is to sell assets (‘Sell to spend’, The Indian Express, January 26). That would also ensure that any consolidation is not pro-cyclical. That appears to be the strategy that the government is following this year. Disinvestment proceeds, strategic sales and spectrum sales are budgeted to increase by 0.45 per cent of the GDP — which is almost identical to the required 0.4-per cent consolidation. What this reveals is that the underlying fiscal stance in 2015-16 and 2016-17 is identical at 4.4 per cent of the GDP. In other words, if these asset sales are achieved, Central government fiscal policy will be neutral and will not impart a negative drag on economic growth. So equity markets can breathe easy. If anything, the consolidated fiscal impulse may be positive as state deficits widen.
It’s important, however, that policymakers double down on execution. Markets will be sceptical given the regularity with which asset-sale targets have been missed in the past. By renaming the department of disinvestment more broadly, the government has revealed it is thinking about asset sales holistically. It’s critically important to follow through on this in the coming months. Interestingly, tax revenue targets were budgeted realistically — almost too conservatively — so they may surprise to the upside to compensate for asset-sale targets that are not met.
Apart from fiscal prudence, there were other positives in the budget. It pledged to amend the RBI Act to set up a monetary policy committee, and introduce direct benefit transfers for fertiliser subsidies and increase automation at fair price shops, which should result in plugging leakages. Additionally, the dispute resolution scheme promises to free up taxman resources, make tax policy more transparent and less arduous for firms and households, and will likely result in more resources being garnered for the government. So it’s likely to improve allocative efficiency all around.
Some may lament that the government did not do enough for growth. It prioritised stability over growth. This presumes there is a trade-off between the two. Instead, emerging markets are replete with examples proving that macroeconomic stability is the foundation on which growth prospers. Think back to 2009-11. Successive fiscal deficits went broke for growth. But that simply sowed the seeds for the mini crisis of 2013. The tightening that was forced on policymakers then slowed growth. As it turned out, the post-Lehman fiscal adventurism got us neither lasting stability nor growth. They say those who ignore the lessons of history are condemned to repeat them. Markets clamouring for a growth budget have clearly forgotten those lessons. Thankfully, our policymakers haven’t.