Even as there has been a slew of comments around the RBI’s surplus-capital transfer to the government, confusion reigns on its macroeconomic implications. There’s a perception that a fresh stimulus of the amount transferred (Rs 1.76 lakh crore) is now available. Consequently, market participants are queuing up to suggest where this fresh spending should be deployed. Indeed, a stimulus of this quantum (almost 1 per cent of GDP) invested in public infrastructure projects — that have large multiplier effects — should be enough to arrest the current slowdown, right?
Not quite. It’s important to understand how this transfer will get absorbed into the Budget. For starters, Rs 28,000 crore of this amount was already transferred and used in last year’s budget. Additionally, the July budget penciled in Rs 90,000 crore as RBI dividends for 2019-20. So this amount has already been budgeted to pay for extant expenditures and is not available for fresh spending. That leaves us with a more modest sum of Rs 58,000 crore or 0.3 per cent of GDP. Won’t additional spending of this quantum boost aggregate demand?
Not quite. That’s because — in all likelihood — these funds won’t be available for financing new expenditure, but will have to be used to reduce the quantum of expenditure cuts to meet this year’s fiscal target of 3.3 per cent of GDP. Why is that? Because tax collections have been budgeted very aggressively. Gross tax collections grew at just 8.4 per cent in 2018-19 off nominal GDP growth of 11.2 per cent (a tax buoyancy of 0.8).
In 2019-20, after adjusting for the tax rate changes, gross tax collections have been budgeted to grow at 15 per cent. Even if nominal GDP were to grow at 11 per cent (the first quarter grew at 8 per cent), this would imply a tax buoyancy of almost 1.4 — the highest in three years. With growth likely to slow further this year, we think achieving a sharp jump in tax buoyancy is improbable. As a case in point, gross tax collections grew at just 1.4 per cent in the first quarter of the fiscal year.
Consequently, like last year, potentially large expenditure cuts will be necessary to meet the fiscal deficit target. In 2018-19, actual expenditures were lower by 0.8 per cent of GDP (Rs 1.5 lakh crore) compared to what was budgeted. Even if tax collections grow at 14 per cent this year — which implies a higher buoyancy despite weaker growth — this would still imply a potentially hefty shortfall of 0.7 per cent of GDP (Rs 1.5 lakh crore) in net revenues, which means spending would have to be cut by a commensurate amount to meet the fiscal deficit target.
This is where the RBI’s higher-than-budgeted transfer will likely be used, because it will ensure that less spending will need to be cut to meet the fiscal deficit target. Therefore, contrary to casual presumption, the RBI’s extra dividend will not facilitate extra spending, but reduce expenditure cuts required to stick to the budgeted fiscal deficit. Qualitatively, the one-time dividend from the RBI constitutes an “asset sale” of the government, because it’s a reduction of the government’s equity in the central bank. It’s important, therefore, that revenues from asset sales are deployed towards creating fresh assets, rather than being used to finance current expenditure.
All told, will the RBI transfer constitute a fiscal stimulus for the economy? At the aggregate level, that would normally depend on whether the Centre’s fiscal deficit widens. If the actual deficit remains at the budgeted level of 3.3 per cent of GDP (as we believe it will) — with the RBI dividends being used to offset tax shortfalls — there should be no stimulus, right?
Not quite. This is because in India asset sales are counted above the line (as a revenue item) instead of below the line (as a financing item), which is how most other countries treat asset sales. Therefore, the true fiscal impulse is determined by deducting asset sales from the fiscal deficit, because asset sales, unlike taxes and duties, aren’t contractionary.
Therefore, even if the deficit stays the same, the fact that asset sales will increase by 0.3 per cent of GDP (on account of the RBI transfer) implies that India’s fiscal impulse will increase by 0.3 per cent of GDP in 2019-20. So there will be a stimulative impact of 0.3 per cent of GDP on the economy. It will, however, not come from new expenditures, but instead from replacing tax shortfalls (which are contractionary) with the RBI dividend (which is not) on the revenue side. So the stimulus will come from the changing composition of revenues rather than new spending — something that’s currently lost on markets.
Of course, this also assumes the RBI dividend doesn’t simply offset shortfalls of other asset sales (disinvestment). The government has correctly set an ambitious disinvestment target of 1.05 lakh crore this year. Now it must follow through. If disinvestment targets are missed, and the RBI dividend simply ends up substituting for that shortfall, total asset sales will not increase this year and there will be no stimulative impact of the RBI dividend at all.
Finally, with the Budget receiving a larger-than-expected windfall from the RBI, reducing the likelihood of any fiscal slippage, government bonds should have rallied, right? Rather, they have sold off in recent days. This is potentially because the special dividend will add to inter-bank liquidity as soon as the government spends it. Therefore, for whatever liquidity target the RBI has in mind, the central bank will have to do 0.3 per cent of GDP less of open market operation (OMO) purchases and/or FX purchases. From the perspective of bond markets, therefore, the number of potential OMOs for liquidity creation reduces, possibly explaining the recent hardening of bond yields.
Contrary to popular perception, therefore, the RBI dividend transfer is not a panacea. At most, we believe it will have a stimulative impact of 0.3 per cent of GDP — and, that too, assuming the steep disinvestment target is met. Instead, what has been very encouraging in recent days is the flurry of announcements by the government to ease frictions and attract more FDI across various sectors. But much more of this is needed. India’s growth slowing to just 5 per cent in the April-June quarter is a stark reminder, as if one was needed, of the severity of the slowdown. We believe India’s economy needs sustained structural reforms to boost potential growth. The RBI dividend, at best, is a cyclical band-aid.
The writer is Chief India Economist at JP Morgan. All views are personal