Dear Finance Minister,
Like I did when I took over as governor of the Reserve Bank of India (RBI), you are going through baptism by fire. It would have been nice to direct your fresh mind, formidable energy and enthusiasm towards drawing up a roadmap to a $5-trillion economy. Instead, barely did you settle into the corner office in North Block you were saddled with what is possibly the biggest economic challenge since the taper tantrum of 2013. Growth has sunk to a six-year low and you are called upon to reverse the slump in the face of heightened global uncertainty, flagging exports, sluggish investments and a stressed financial sector.
You have already announced a slew of measures to front-load expenditures and comfort investor sentiment. The RBI has cut rates and is pumping in massive liquidity. I gather from your statements that you are considering further measures. This letter is not about what you should do next but about what you should not. You should not launch a fiscal stimulus. A lot of people must be advising you that if there was ever a time to open the money spigots, now is it. My unsolicited advice to you is that don’t succumb to the temptation. Here is why.
You simply don’t have the fiscal space. Everyone, including you, knows that the actual fiscal deficit is higher than what is shown in the budget. Tax receipts during the past two years have been short of budget estimates. In order to show that the fiscal deficit target has been met, despite the revenue shortfall, the government resorted to massive window-dressing of expenditures, including withholding payments to public enterprises.
It’s completely irrational to not admit the true fiscal deficit. We are fooling no one, least of all potential investors who base their decisions on our macro sustainability. We can persist with our denial, but that’s hardly going to protect us from the ruthless penalties for fiscal irresponsibility.
Analysts who have poured over the numbers are telling us that the prospects of achieving this year’s budgeted fiscal deficit are even more dire. At first glance, the tax revenue growth you projected in the July budget seemed reasonable. That comfort, though, was short-lived. When compared with the actual tax collections of last year, the data was released subsequently, this year’s projections are decidedly unrealistic.
Amidst all the challenges you are facing, a bit of luck has been the generous dividend from the RBI to the extent of 0.3 per cent of GDP beyond what you had budgeted for. That will fill the fiscal hole to some extent. But that is a one-off. What will you do next year when RBI transfers revert to trend, as I expect they will?
Let me also tell you another thing you should worry about, not that a conscientious person like you needs being reminded. You should worry about the growing revenue deficit. For some reason, the revenue deficit has gone off the radar, and that’s not a good thing. Borrowing to meet current expenditures is never sustainable. If on top of this worrying state of public finances, you opt for a fiscal stimulus, the damage will extend far beyond your current term. And the economy will pay a heavy price.
I am sufficiently clued into the debate to know what arguments the supporters of stimulus might be making to you. Let me address them.
First, they will be telling you that the egregious impact of fiscal excess is felt through higher inflation, higher interest rates that will crowd out private investment and a higher current account deficit. All of these, they will contend, are within comfort range, giving you room for a stimulus. Such complacency is completely unwarranted. I don’t have the space to detail all the past episodes, but you are surely aware that every time we have indulged in fiscal excess, believing that “this time is different”, we ended up in a crisis or a near-crisis.
Second, the stimulus supporters will argue that India’s debt-to-GDP ratio is low in comparison to its peers. Data doesn’t bear this out. In any case, experience as well as research shows that international comparisons of debt to GDP ratios, without reference to other parameters, are misleading.
The third argument fiscal doves will make is that it is wooden-headed to remain committed to fiscal responsibility when the economy is in a serious downturn. Fiscal adjustment should be done over a cycle, saving in good times for spending in bad times. This is an appealing argument in theory but will not work in practice, especially in a boisterous democracy like ours. Which finance minister will take the pain of saving to give his successor the pleasure of spending? Yes, fiscal adjustment over a cycle is a good idea, but it will have to wait till our fisc gets robust. For now, being wooden-headed is not just good, but imperative.
The more savvy of the doves will also invoke the IMF finding that in the midst of the eurozone sovereign debt crisis of 2011-12, fiscal austerity was militating against growth. But that finding does not apply universally across space and time. It may have been fiscal austerity vs growth for them, but for us, it has been and still is, fiscal austerity for growth.
Fifteen years ago, C Rangarajan and I published an article with a similar thrust as this one. That the message is still relevant is an indication of our unchanging challenges.
You have a tough job, madam. My best wishes for your success.
This article first appeared in the print edition on September 18, 2019 under the title ‘Austerity for growth’. The writer is former governor of the Reserve Bank of India.