Worrying macro dynamics

The downgrade of India’s sovereign debt rating by Moody’s Investors Service has largely been shrugged off by the markets. Perhaps it was already priced in, as the downgrade brings that agency’s rating in line with those of the other two at the lowest rung of investment grade. But nevertheless the downgrade does signal service by highlighting an emerging scenario when it comes to India’s macroeconomic dynamics. Moody’s claimed that it expected general government debt to rise from 70 per cent of gross domestic product (GDP) to around 84 per cent. This tells a story that is reinforced by the data releases from last week. The GDP print, for example, showed that in 2019-20 it grew at only 4.2 per cent. But, while gross fixed capital formation shrank, government consumption expenditure actually increased at the rate of about 12 per cent, dwarfing the 5.3 per cent growth rate of private consumption expenditure. In the previous year, as well, government expenditure growth had outpaced the other components of GDP. Unsurprisingly, the result is growing fiscal stress: The Controller General of Accounts said on Friday the reported Union fiscal deficit for last year was at 4.6 per cent. This is higher than what the National Democratic Alliance inherited six years ago, undoing one of its main achievements.

In essence, the government’s spending is now the only engine of growth in the economy, which is causing fiscal mayhem and has disrupted borrowing requirements. After the pandemic hit, the finance ministry further enhanced the government’s borrowing requirements, and they are now at around Rs 12 trillion. The interim Budget in 2019 suggested that gross market borrowing would be around Rs 7 trillion in 2019-20, but this estimate had to contend with a shortfall in tax revenue; the most recent Union Budget put market borrowing for the ongoing year at Rs 7.8 trillion, which has now been enhanced. As tax revenue stagnates or falls — net tax revenue to the Union was only Rs 13.6 trillion in the year just concluded, according to the Controller General of Accounts — borrowing has grown. These are uncomfortable debt dynamics for any country, but particularly so for an emerging economy that has levels of debt higher than most of its peers. The low oil price and the comfortable external account continue to insulate India from consequences being faced by commodity exporters with worse macroeconomic dynamics. But who knows how long that will last?

Using the government to borrow and spend to prop up growth may be feasible at a time when the private sector is semi-comatose, as it is now. But it has become increasingly obvious that it is not sustainable over time — even if it succeeds as a growth-revival strategy. After all, if sentiment revives and private-sector demand for credit consequently grows, what will be the consequence? The government is monopolising the investible surplus in the country, and foreigners are reluctant to lend to the Indian private sector. Will the government be able to compress expenditure at that point? Or does it hope to squeeze enough revenue from a recovering economy that the borrowing programme comes under control once again, and stops crowding out the public sector? The government and the Reserve Bank of India would do well to consider limited monetisation of debt to bring the overall money market situation under control. 

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