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Monday, April 19, 2021

Sajjid Z Chinoy: Now that fiscal policy has come to forefront, central banks need to step back a little

Given the blow from the pandemic, the Budget was seen as make-or-break for the economy. Has it delivered?

Written by P Vaidyanathan Iyer
Updated: March 9, 2021 2:29:27 pm
Sajjid Z Chinoy, Chief India Economist at J P Morgan. (Express photo)

Given the blow from the pandemic, the Budget was seen as make-or-break for the economy. Has it delivered? In this session before a nationwide audience, Sajjid Z. Chinoy discussed what the Budget seeks to achieve, and what is the way forward from here. Edited excerpts:

On how the Indian economy is placed as the IMF revises global projections upwards

The second half of 2020, helped by continued fiscal policy stimulus in developed markets and very accommodative central banks around the world, came in stronger than what the IMF had originally forecast. But when you scratch below the surface, what you will find is that, apart from the US and China making complete recoveries, this is still a very incomplete recovery around the world. Despite the improved outlook, global activity will still be about 4 percentage points below its pre-pandemic path, which is a large shortfall.

From India’s perspective, what matters is some of the tensions that will be generated through the divergences in the global recovery. We are seeing a lot of divergences: geographically, sectorally, inter-temporally, and across factors of production. Very strong growth in the US, much less so in other parts of the world. Very strong growth in the goods sector, much less so in the services sector. Very strong growth of profits, much less so for labour and for wages. Normally when you have strong US growth, you tend to have a big spillover effects to the rest of the world, and when you get a synchronised global recovery, the dollar tends to weaken and that is good for emerging markets because capital flows into emerging markets. If, however, we get US exceptionalism – which we are currently seeing –the spillover to the rest of the world could be much lower than believed. And if that happens, you can get a stronger dollar. Now if you get a stronger dollar, and you get stronger oil prices – as we are currently witnessing – that will create some pressure for some emerging markets. We need to be mindful of these kinds of tensions despite the fact that the global economy is doing much better than we thought six months ago.

On whether the Budget projections are realistic

This is one Budget where I think the numbers are actually quite conservative. Normally we have a situation where we always worry about tax targets, and therefore fiscal slippage. But let’s start with FY21 and what the Budget presumes. For the RE (revised estimates) targets to be met this year — taxes net of excise — will have to contract by 20% in the January-March quarter. These taxes grew 25% in the last quarter. So my sense is that you could actually get an upside surprise this year when the final FY21 number prints in May.

This is important because it also forms the base for next year and if this year’s tax revenues are higher, then the asking rate that’s required for next year’s tax targets is going to be lower. So again, if you take excise out of the picture, the tax buoyancy that is assumed to get to next year’s number, it’s actually 0.8 — less than 1. So one of the paradigm changes is that you are seeing is conservatism, welcome conservatism, on the revenue side. I think we could also be surprised to the upside in terms of GDP growth, not because I want to make any heroic assumptions but if you just look at the quarterly trajectory of growth, and if you even presume a 4-4.5% quarter-on-quarter annualised momentum, then the full-year number for 2021-22 could be as high as 13%. If you add a deflator of 3-3.5%, you may end up with a nominal GDP of 16% or 17%. This doesn’t mean India is booming, this would still be an incomplete recovery. Even if we grow 13% next year, India will still be 6-7 percentage points below its pre-pandemic path.

On the projected fiscal deficit of 9.5%

In recent years, we had worried that the RE might slip because the last quarter’s revenues (January-March) don’t materialize. We actually think the upside surprise to revenues for FY21 could be as high as half a percent of GDP. So in May, when the CGA numbers come out, it is possible that deficit this year is closer to 9%, not 9.5%. One of the reasons it was different from the 7% that most analysts had forecasted, was that about 1.7% of GDP in terms of food subsidies, which analysts had forecast would be on FCI’s balance sheet, came back on to the Budget. So if we end up with a 9% deficit and a lot of that is because of a one-off increase in subsidies, next year’s subsidies automatically reduce by about 1.6% of GDP. Effectively, therefore, the consolidation next year is from about 7.4 % of GDP to 6.8% of GDP, which is more achievable.

On the choice between a capital expenditure-driven approach and a cash support approach

One is more relief, the other is more of a stimulus. Ideally, you want a mix of both. I think capital expenditures are important given India’s growth dynamics in the last three years and a decline in the aggregate investment rate. If India needs to get into a virtuous growth cycle, growth will have to be investment-led. In this environment, therefore, you will need a public investment push to crowd in the private sector. I think this is equally true of the states. We focus so much on the Centre; the bulk of CapEx happens in states. So it’s important that states have the resources and wherewithal to ensure that they are not cutting down on CapEx in the next few years.

On downside to CapEx-led growth

Implementation is the most important part. There are always execution and implementation risks associated with capital expenditure. Now if you look at where the spend is expected to be over a two-year period (FY22 over FY20), a lot of it is in highways, railways, urban housing and urban infrastructure, with large multipliers. But execution is the key. The design of the Budget was the appropriate one, given the current macro environment, but the main challenge will be execution. Not just execution on the capital expenditure side, but also execution on the disinvestment side. More generally, I think of this as an asset swap, because across a two-year period, CapEx has gone up 0.8% of GDP, effectively financed by a 0.6% increase in asset sales. So we have to deliver on those asset sales to generate the resources to ensure the CapEx gets done.

Sajjid Z. Chinoy in conversation on Zoom with P Vaidyanathan Iyer, National Affairs Editor, The Indian Express

On whether India has to be watchful of the markets

I don’t think we should necessarily judge the state of the economy by markets. I think around the world there is a huge wedge between market evaluations and where the underlying economy is. On capital inflows, India is doing the right thing. The balance-of-payments surplus in 2021 could be about $90 billion, both because we have run a current account surplus for the full year, and we have strong capital flows, and it was important, from a competitiveness perspective, not to let the Rupee strengthen too much.

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On the impact of oil prices

India being a very large importer of oil, there are huge terms-of-trade changes when oil bounces around so much. In the past, we’ve been a beneficiary of these terms-of-trade changes… Now, as oil prices move up, we’ll have to make difficult choices. One is, do you cut excise duties to prevent retail prices from going up further? But then if you cut excise duties it will hit revenues. Does that then mean you may have to cut capital expenditure, which could impact job creation, for example? These are difficult choices; there is no right answer.

Perhaps what we need to do is to balance the costs. It should be shared across all stakeholders. Beyond a certain point, letting retail prices increase could impact inflation expectations. Now you don’t want inflation expectations to go up very sharply especially since food prices for much of last year went up and they impacted expectations. Perhaps we want to balance out how much of this is absorbed through higher retail increases, which helps preserve revenues and generates more expenditure, and how much of this is absorbed through excise duty cuts, which keeps retail prices capped.

The third impact is on the current account. India will be moving from a current account surplus this year of 1% of GDP to a deficit of about 1-1.5% of GDP. While this is not threatening, it’s a 2-percentage-point swing in a year. What that also tells you is that the extraordinary savings we got in the Covid year, won’t be there. More generally, the private sector savings-investment balance will adjust, savings will fall, investment will go up — that’s a healthy thing, but it will also have implications for equilibrium interest rates and bond markets.

So this is a very complicated phenomenon. High oil prices affect all parts of the economy: growth, fiscal balances, the current accounts and inflation. Let’s hope that you don’t get a very big pick-up in oil prices because that severely reduces macroeconomic degrees of freedom.

On monetary-fiscal policy coordination

I think the fiscal-monetary mix right will be very important for the sustainability of the recovery. RBI was the prime mover in 2020, lots of rate cuts, lots of liquidity, lots of forbearance, like other central banks. Now fiscal policy has picked up the baton, which was the right thing to do. But now that fiscal policy has come to the forefront, around the world, I think it will mean that central banks need to perhaps step back a little bit. In India, we have had exceptionally accommodative monetary policy and I think over time you want to gradually withdraw that, in a very non-disruptive manner. As the recovery gets more entrenched, you want fiscal and monetary policy to become substitutes. During a crisis, you want them to be complements. But as the recovery gets more and more entrenched, you want fiscal and monetary to become substitutes so that you avoid any financial stability concerns down the line.

Transcribed by Mehr Gill

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