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Monday, May 25, 2020

Government should target a structural deficit as an alternative to the fiscal deficit

The figures on the expenditure side of GDP do not foretell a promising picture. The decline in private final consumption expenditure is a matter of concern, though an increase in government final consumption expenditure has been able to offset it.

Written by Soumya Kanti Ghosh | Updated: June 3, 2019 9:56:24 am
indian economy, fiscal deficit, bank credit, bank credit growth, indira gandhi, msp, indian express “The Indian economy is likely to recover from the impact of demonetisation and the GST, and growth should revert slowly to a level consistent with its proximate factors — that is, to about 7.5 per cent a year,” the World Bank report said.

Friday, May 31, was an interesting day in Indian politics and economics. On the economics front, Q4GDP numbers plunged to a 20-quarter low while annual growth came to a five-year low of 6.8 per cent. However, despite much scepticism, India could stick to its fiscal deficit of 3.4 per cent for FY19. Bank credit growth declined by Rs 1.5 lakh crore in April, but this has always been a seasonal phenomenon. On the political front, the country got its first woman finance minister (PM Indira Gandhi did hold the portfolio, but that was only as an additional charge) in 72 years.

Domestic growth was even weaker than what was expected. Manufacturing GVA, which grew by 12.1 per cent in Q1, decelerated sharply, growing by 3.1 per cent in Q4. This was expected, based on the Q4 FY19 results of 932 listed corporates — around 550 companies had reported either negative or single digit revenue growth. For FY19, manufacturing GVA grew by 6.9 per cent compared to 5.9 per cent in FY18. Core GVA, an indicator of private demand, slowed down to 6.1 per cent (the lowest since Q2FY18).

Agriculture and allied activities grew at 2.9 per cent in FY19, compared to last year’s growth of 5.9 per cent. In Q4, the sector registered a negative growth of 0.1 per cent. However, the good thing was that the agricultural price deflator, an indicator of rural purchasing power, has finally recovered in Q4 after two successive quarters of de-growth. In fact, our estimates suggest that since the MSP increase in July 18, wholesale prices of 18 major crops (includes cereals, pulses and oil seeds) have recovered from lows and are now on average 10 per cent higher than the MSP. However, such rise in mandi prices has no material impact on retail food inflation, which seems to have declined even as wholesale inflation has moved up. The divergence is a matter of debate, but low inflation now seems entrenched in India’s psyche.

In this context, the government decision to now extend the PM-KISAN scheme to all farmers is a positive step. We also did some rough estimates to find out the fiscal cost of such an ambitious programme over the next five years. Our calculations suggest that even if we progressively increase the income support from, say, Rs 6,000 to Rs 8,000 in the terminal year (inflation indexed) and reduce the fiscal deficit to 3 per cent in 2024 (with a nominal GDP growth of around 11.5 per cent), the additional cost for 14-crore farmers over the baseline estimates could be Rs 12,000 crore per annum, same as the revised estimates if only Rs 6,000 was provided to all 14 crore during the next five years. We need a definitive consumption push in rural areas.

The figures on the expenditure side of GDP do not foretell a promising picture. The decline in private final consumption expenditure is a matter of concern, though an increase in government final consumption expenditure has been able to offset it. After reaching a high growth of 9.8 per cent in Q2 FY19, PFCE growth declined to 7.4 per cent in Q4. The growth in gross fixed capital formation dipped to 3.6 per cent in Q4FY19, which is the lowest in the last eight quarters. It seems that election uncertainties have taken a toll on investment and government spending.

On the fiscal front, the latest data shows that the government has been able to meet the revised fiscal deficit estimate of 3.4 per cent of the GDP. However, there has been a Rs 1.45 lakh crore reduction in expenditure with a Rs 69,140 crore cut in subsidies (majorly food subsidy), covering for Rs 1.57 lakh crore reduction in total receipts. Now that FY19 estimates are revised, the FY20 BE may be on the higher side.

The problem is that global uncertainties have compounded in recent times. Tax cuts by the US did not have much impact on its growth last year and going forward there is not much room for further support. World trade growth is likely to remain weak into the second quarter of 2019. The latest World Trade Outlook Indicator (WTOI) remains well below the baseline value of 100 for the index, signaling continued falling trade growth in the first half of 2019. The outlook for trade could worsen further if heightened trade tensions are not resolved or if macroeconomic policy fails to adjust to changing circumstances. For example, the ongoing trade skirmish between USA and China is showing no signs of abating with the US increasing tariffs on Chinese products. China, in retaliation, has said that it will raise tariffs on $60 billion worth of US imports starting June 1. There are even concerns about the tariff war spilling over to financial markets in the form of China cutting its exposure to the US treasury market. Worsening economic indicators in the US, like student loan delinquency and yield curve inversion (the worst since 2007), as well as US exports getting squeezed by trade wars, are also going to pose challenges for the US economy.

Given the growth slowdown that the country is facing, the question arises whether the government should continue to focus on the path of fiscal consolidation or keep deficit numbers constant for the next two years at 3.4 per cent (or keep it marginally higher), before reducing it as growth revives. We believe that the government should target a structural deficit as an alternative to targeting the fiscal deficit, like most advanced and several emerging economies. This serves as an automatic counter-cyclical stabiliser unlike the current target that has been set from the outset as a fixed percentage of GDP and is a statistical misnomer. But, for sure, fiscal policy should be transparent and credible, and we must strive for what we can achieve through resource mobilisation, and not through expenditure compression.

We also expect monetary policy support to complement fiscal policy in the interregnum. The RBI could also advise banks for effective rate transmission (the SBI has proactively moved to external benchmarking of the repo rate to lending rates, there is no harm in replicating this).

We end on a positive note. Recently, S&P Global Ratings upgraded Indonesia’s sovereign rating to BBB from BBB- just after the re-election of President Joko Widodo. Strong economic growth prospects, low debt, an infrastructure drive of more than $400 billion and prudent fiscal policy enabled the upgrade. India has also seen the re-election of the Modi government with an even larger mandate. Uncanny similarity for S&P?

The writer is group chief economic advisor, SBI. Views are personal. This article first appeared in the print with the title ” As demand slows down” on June 3, 2019. 

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