In two weeks, Finance Minister Nirmala Sitharaman
will present the first Union Budget of Prime Minister Narendra Modi’s second government. Fundamentally, the Budget is a statement of account of the expenditure and revenue of the Union Government. Unsurprisingly, therefore, the one statistic most eagerly awaited is the fiscal deficit, for the year gone by and the year ahead. But since the Union Budget is more than just an accounting exercise — it is a state of the economy and path of reforms address — the statistic that should take priority over all others is the rate of growth. In a scenario where annual growth is at a five-year low (and quarterly growth below 6 per cent), should the minister’s main concern be meeting the fiscal deficit target of 3.4 per cent come what may or should the main concern be boosting the growth rate?
For a country that has a long history of fiscal profligacy, the recent trend towards fiscal responsibility is a radical change. But what is fiscally responsible must be defined by the state of the economy. For now, the government’s target is the FRBM mandated 3 per cent of GDP.
Apparently, the 3 per cent figure was arrived at by an assessment of the demand and supply of resources in the economy with a view that the government does not crowd out more productive private investment. Curiously, it is the same target as the one for member states of the European Monetary Union that are far more advanced economies. That said, the single 3 per cent target cannot be suitable for all scenarios. There must be more flexibility when the economy is in a slowdown characterised by sluggish private investment. As a corollary, the target could be tighter in a private investment-led boom.
For the moment, the Indian economy is stuck in the former. Investment as a percentage of GDP
has stayed below 30 per cent of GDP
for the last five years — at its peak it was around 36 per cent of GDP. The private investment cycle has shown little signs of revving back to speed. The reasons for sluggish private investment are not macroeconomic. They are structural. Fiscal restraint, while always sensible, isn’t going to get the economy out of the growth rut.
It is important to remember that there are two sides to the fiscal deficit equation — expenditure and revenue. Modi
1.0 began its tenure by trying to shift the emphasis of expenditure from revenue expenditure to productive capital expenditure. That effort ran out of steam towards the end of the government’s time in office. However, at this stage, it does not make sense for the government to cut its capital expenditure further given that private investment is not making up for the slack. It would be ideal if the government cut its revenue expenditure but between establishment costs and election promises that is unlikely to happen.
The temptation for the government may be to shore up the revenue side. As long as the government focuses on non-tax revenue by pushing an aggressive disinvestment programme — of PSUs and their assets — it is on the right track. If, however, it focuses on the taxation route, the outcome could depress growth further. The government must honour its commitment to lower the corporate tax rate to 25 per cent for all companies. It must also remove unnecessary cesses. It must also provide, where necessary, fiscal incentives to industries which could generate employment on a large scale. At any rate, it must desist from setting impossible targets for tax officials which lead to unintended consequences — like the retrospective tax amendment which continues to be a deterrent to investment to this date.
If the choice before the finance minister is meeting the fiscal deficit target of 3.4 per cent by continuing to squeeze on the tax front or missing the fiscal deficit by 0.3 to 0.4 per cent by cutting taxes, cesses (at least not raising any) and settling lingering disputes to boost investment, then Sitharaman must opt for the latter. The economic cycle demands that.
Of course, such a stance must not be viewed as fiscally irresponsible. So, any relaxation of the deficit should not involve runaway revenue expenditure. It must serve as a boost to investment, private and public. It is an opportunity for a new finance minister to recalibrate the orthodoxy around fiscal rectitude. Instead of 3 per cent for all times, why can’t it be 2 per cent and 4 per cent depending on the economic cycle. It may also be time for the FM to emphasise the importance of a zero (or close to zero) revenue deficit rather than solely obsess about the fiscal deficit which may be sustainable if the expenditure is flowing to productive uses. Modi’s economics has leaned towards being practical than textbook. It should be the same for the fisc.
The author is chief economist, Vedanta