The fog of fiscal finances

A string of new expenditure is clouding India's fiscal future

A fog has set in over New Delhi, and it is not just weather related. The fiscal outlook for the medium term seems unclear.
 
It began in 2018, when the much-needed new fiscal rules (Fiscal Responsibility and Budget Management — FRBM) were enacted in Parliament. They make public debt the main anchor of the fiscal framework. They stipulate that overall (centre plus states) debt should not exceed 60 per cent by the end of FY25, down from over 70 per cent now.
 
So far, so good.
 
The inconsistencies began when, around the same time, several new spending plans with substantial costs were announced – a string of farm loan waivers, bank recapitalisation bonds, a new healthcare scheme, and higher minimum support prices (MSPs). Over 2018, these spending plans were scaled up further — more farm loan waivers, more direct farmer income support measures, and additional bank recapitalisation bonds.
 
Don’t get us wrong. We are not against these expenditures and that is not the focus of this oped either. We are just pointing out that the new debt targets will become hard to meet under the weight of these new spending pressures.
 
Our debt analysis suggests that to meet the public debt-to-GDP ratio target of 60 per cent, the centre and the states would need to jointly double their efforts on fiscal consolidation: Lower the overall fiscal deficit by 1.4 per cent of GDP over the next seven years vs the 0.7 per cent of GDP decline in the past few years. However, even that may not be enough: Once we include the new spending commitments, even a doubling of effort is insufficient.
 
Missing FRBM targets could have implications for the debt market, sovereign ratings, and economic growth and stability. No one seems to be acknowledging this as yet. And that’s perhaps reason enough that someone should bridge the gap before it is too late.
 
How are things looking currently? Even though the central government may meet the 3.3 per cent fiscal deficit target for this year, it will be painfully done, requiring sizeable expenditure cuts and relying on a higher interim dividend from the Reserve Bank of India (RBI) and dipping into the GST compensation pot which was meant to be locked away for five years.
 
State governments do not seem to be consolidating their deficits either. They are likely to see 22 per cent growth in borrowings in FY19. The state government bonds (also known as SDLs) spreads over the central government bonds, which reflect the market’s perception of the risk associated with SDLs, have risen quickly over the last few weeks.
 
Looking closer shows that markets are feeling the heat from too much public sector (central and state government and public sector undertakings) borrowing. The “net supply” of paper (after accounting for the regulatory demand from RBI’s Open Market Operations (OMO) purchases and SLR requirements) rose sharply in FY18. 
 
One could argue that some of these fiscal pressures will abate once the national elections are over. The country will comfortably get back on to the new FRBM track. However, look closer and you will find that many of the spending plans are more permanent in nature. And, at any point in time, a handful of India’s states are close to an election.
 
And yet, there may be some hope of meeting the debt target. GST revenues could rise quickly over the next few years. And some believe that a sizeable "excess" dividend from the RBI could help the government finances too. How real are these hopes?
 
On the GST front, the ask is too high (though not impossible). By our calculations, tax revenues would have to rise faster than nominal GDP growth for the next six years to meet the debt target in the face of higher spending commitments.
 

Calculations of the RBI’s "excess" capital (if any) are fraught with definition issues and are sensitive to the assumptions used. Even if some "excess" is identified, every channel of transferring the funds to the government will come with some uncertainty. For example, a larger transfer of future profits, even if mandated, may not guarantee a steady stream of revenue each year. A transfer of some stock of “excess”  capital could stoke inflation, calling for tighter monetary policy, which may ultimately hurt private enterprise.
 
At the heart of all this is a vacuum. There is no agency in the government that looks comprehensively at both the central and the state fiscal costs and revenues, relating them to the fiscal rules that the country has enacted. Without such counsel, the government risks making sub-optimal policy decisions.
 
The FRBM committee report of 2017 called for such an institution, naming it the “Fiscal Council”, and even highlighted the key roles it could play. The idea was to create an institution that provides clear analytical inputs and works with the government to deliver better fiscal outcomes.
 
One thing seems clear amid all this haze — it’s time the Fiscal Council was set up. The writer is chief India economist, HSBC Securities and Capital Markets (India)