Fiscal Orthodoxy: Will Jaitley Follow The Road To Economic Ruin Laid By Chidu?

Fiscal 2016-17 has not exactly gotten off to a roaring start for the NDA government. The fiscal deficit for the first two months, out last week, was 43 percent of the whole year’s target, much higher than last year’s 37.5 percent around this time. Nothing to be alarmed at, but worth noting nevertheless.

The Index of Industrial Production (IIP) fell by 0.8 percent in April after managing barely 2.4 percent in 2015-16. And May 2016 is unlikely to be any better, if the core sector index is any guide. Eight core sector industries, which account for nearly 38 percent of the IIP, saw output fall from April’s 8.5 percent to 2.8 percent in May, which suggests that the IIP number due next week is not going to set the bourses on fire.

The world, thanks to a further impetus from Brexit, is heading further downhill. When the World Bank comes out with its update of global growth forecasts for this calendar, it is likely to mark down its earlier 2.9 percent estimate, which was itself a fall from its earlier optimistic forecast of 3.3 percent.

If the world is not going to help us grow, we have to do it ourselves. And it means temporarily abandoning extreme orthodoxy on the fiscal roadmap. India should consider abandoning its fiscal deficit target of 3.5 percent this year and peg it closer to last year’s figure of 3.9 percent. The West abandoned it long ago, but wants to shove this idea down our throats when we can least afford it.

If we stick to 3.5 percent, and assuming we see no revenue miracles this year, Arun Jaitley will be leading the economy down the same cul-de-sac that P Chidambaram led us to in 2012-14.

Reserve Bank Governor, Raghuram Rajan, in a panel discussion last month in Basle, criticised the West for “expecting emerging markets to be ‘orthodox’ in their monetary and fiscal policies at a time when they themselves have ‘thrown out orthodoxy out of the window.’” Rajan also said that central banks had no “bazooka” to fix growth issues, and they should stop pretending they had one, reports The Economic Times.

What is sauce for the goose is sauce for the gander. What is good for the West should be at least as good for us.

And it isn’t only Rajan saying things like this. Chetan Ahya, Chief Asia Economist at Morgan Stanley, has said that the west has to shift the burden of stimulus to fiscal policy, now that monetary policy has run out of fuel. He wrote in a recent column: “Now, the effective solution to prevent a relapse into recession would be to reactivate policy stimulus. Although there is some space for monetary policy, we are approaching the limits, and the effectiveness of monetary easing is waning. Fiscal policy can be employed to boost demand…There is undue concern over running high fiscal deficits, particularly at a time when the need of the hour is to ensure that aggregate demand is supported via boosting public demand.”

This advice, of course, is meant for Europe and America, if not Japan and China, but this is good for us too, in a modified form. Our problem is not demand per se, but investment slack. The remedy for a “balance-sheet recession” is not more fiscal austerity.

While agriculture is expected to be the bright spot in the economy this year, thanks to expectations of a good monsoon, a good monsoon usually translates to higher costs for the exchequer – higher fertiliser and food subsidies. The better agricultural performance will result in improved demand after a lag, which could mean the last quarter of 2016-17 or the first quarter of 2017-18.

The Seventh Pay Commission payments, which will get backloaded in the second half of this year, will also give demand a boost, again with a timing similar to agricultural demand.

What this implies is this: government expenditure on subsidies to agriculture and payouts to central staff will bloat the fiscal deficit this year. It will come back in tax revenues only later, after economic activity grows. Additionally, there is the need to keep public sector investment up this year. Then there is the bank bad loan portfolio, which again needs more government money. Without more capital bad loans will kill off all lending, which is not good for anybody. We can kiss goodbye to a resumption of the lending-investment cycle in the private sector without more capital infusions in public sector banks. But this again means a higher fiscal deficit.

In this context, the budget promise to cut the fiscal deficit down to 3.5 percent this year is not brave but foolhardy.

The only way this target can be achieved in a year of major expenses is by curtailing public capital spending, which is exactly the problem left behind by Pranab Mukherjee and P Chidambaram. They cut out the good expenditure and kept the bad, thus putting the Indian economy into a tailspin.

Does Arun Jaitley want to repeat the mistakes of the UPA? He has to rethink the fiscal roadmap. A pause, or a very small reduction, is what the doctor ordered for the Indian economy.

Jaitley should not take us down the Chidambaram path of ruin, of cutting the branch on which the economy is sitting. A slight relaxation in the fiscal deficit target this year will be repaid in spades next year when the economy is firing on all cylinders.

The only situation iN which the fiscal target makes sense is if there is some revenue bonanza somewhere, whether in the form of spectrum revenues or an unexpectedly large declaration of undisclosed income (and hence payment of penal taxes) in the scheme now open till 30 September.

But higher tax revenues are, by definition, contractionary till the money if spent again by government. Spectrum revenues will come from corporate profits or bank loans; tax penalties paid by former tax evaders will eat into the current cash flows of those disclosing concealed incomes.

It is best to recognise reality and make the fiscal target this year flexible. Next year would be a better one for reinstating fiscal orthodoxy.