Putting forward the government’s view on the high level of fiscal deficit, chief economic adviser in the finance ministry, Arvind Virmani, claims the 6 per cent deficit is reversible and should not affect India’s sovereign rating. In an interview to John Samuel Raja and Prashant K Sahu, he says most expenditure items are one-off and will not recur. Excerpts:
A lot of questions have been raised on the high deficit — whether it is sustainable and its impact on the economy. How would you justify the high level?
What is the problem you are trying to solve? We started the year with high commodity prices and certain policy actions were taken. Though the global crisis was on for about a year, it hit us in September (2008). What is that we are trying to address? First, the financial or monetary aspect, which RBI tackled. Second, the impact on the real economy through exports and global slowdown on investments.
The fiscal action has to be taken in this context. We started this year with a forecast of 8.5 per cent, plus or minus 0.5 per cent growth. Then there was a shock in the economy and we have to counter it. The expansion in fiscal deficit is substituting for that demand. Last year, the fiscal deficit was 2.7 per cent of GDP; this year, it is projected to be at 6 per cent. That’s a fiscal expansion of 3.3 per cent.
People seem to think whatever has happened to the deficit had occurred; thereafter, we tried to do something. This is not true. A fiscal stimulus is a total change in fiscal deficit. We look at the implications of things that are happening and see if we need to counter these or not. It turns out the two important elements thought of in February 2008, and not in anticipation of crisis, the loan waiver and the sixth pay commission (SPC) became operational in October. It turned up at the right time, right when it was needed.
Then there are automatic stabilisers, where you consciously allow this to happen. When taxes fall in normal times, one would take measures to counter that. This time we did not, so that the demand stimulus happens.
The third is active things being taken — cut in income taxes at the beginning of the year and excise duty cut.
Oil bonds were not part of the fiscal deficit. Isn’t it sort of paying to foreign suppliers?
Oil bonds should be seen as a counter to the oil price increase, which would have had a deflationary impact. This is also part of the stimulus. Not as a result of meltdown, but the oil price increase would have negatively impacted consumption. So, the oil bond is an offsetting stimulus. Overall, the fiscal stimulus is 3-4 per cent in 2008-09, one of the highest in the world.
Going forward, the same principle applies. A 5.5 per cent deficit in the next fiscal includes some part of loan waiver and 60 per cent of SPC arrears, plus other expenditure in the Budget. In addition, the FM said we would consider a further 0.5-1 per cent. Being continued because the global situation that made demand slow down is likely to continue in the next fiscal, too. Otherwise we will raise taxes.
Would there be any need for fiscal stimulus in 2010-11?
At this point, we expect the need for any stimulus will disappear in the year after 2009-10. I expect the economy to be back to the trend growth rate. So, we should be going back to the 3 per cent FRBM (Fiscal Responsibility and Budget Management Act) target.
As an economist, what would constitute an ideal fiscal stimulus if there was no SPC and debt waiver scheme?
It would have been impossible to have a stimulus that would have been operational immediately. In that sense, it was very timely. Traditionally, there is recognition that monetary policy is faster than fiscal because of the (latter’s) political element, which is more contentious. It’s not true of monetary policy, and (so, it) is first line of defence. It’s fortunate that these two came when the meltdown started. It has turned out to be a blessing.
What do you do? Accelerating infrastructure and social sector spending is one thing. Taxation is another aspect.
The finance minister said there would be additional 1 percentage spending if required. How would you like it spent?
That’s for the planning commission to decide. They have to decide on two things. First, where it is being usefully spent. Second, where it is feasible. That’s a decision they will have to take and tell us.
At this high level of fiscal deficit, does the government have space to spend more?
The headroom for fiscal deficit is the difference between the trend growth and actual growth. We don’t want a fiscal stimulus when you’re already in trend growth, then it would be inflationary.
Would it be easy to reverse tax concessions given to petroleum products and excise duty?
The whole issue of decontrol is there. The new government should address it. There should be a rational tax system. One of the things we recommended as part of the B K Chaturvedi report was to make things transparent, separate taxes from basic price. In many cases, state governments levy huge taxes which are higher than what the Centre levies. All these reform issues need to be addressed and are essential for long-term growth.
Do you think sovereign ratings would be impacted because of higher fiscal deficit and high market borrowing? (the interview was done before S&P reviewed its outlook for India’s sovereign rating)
It’s exactly the same question rating agencies ask. My counter question is: are you downgrading other countries, are you downrating the US, Japan? Everybody recognises that you’re operating below the trend and it’s not inappropriate to raise fiscal deficit, including debt rating agencies. The question they ask is, will you have the will to go back to the proper fiscal thing after the crisis gets over?
The FM clearly said that we intend to go back once the current crisis is over. At this point, as an economist, we would get back by 2010 onwards.
The fiscal deficit cannot be a reason for downgrading India’s rating. If they give other reasons, it’s another matter. The interest rate is also a transfer from government to savers. If you’re a saver, you will have additional money.
What factors will help to restore fiscal discipline?
The three things are reversible. SPC and farm waiver would be over. The automatic stabilisers would automatically reverse. When the Goods and Services Tax (GST) comes in, we would get higher revenues, as experience shows across the world. All the factors I think of are reversible and the government has a clear intention to comply with the FRBM Act.
On the question of government borrowing crowding out private investments?
Investment is likely to slow down. Credit requirement for private sector is lower. That is why the government wants to increase public investment in infrastructure and borrow to finance. When private investment comes back on line, then we should go back.
The link between interest rates and the yield on government bonds is getting severed, as the 10-year-yield on G-secs has moved up even after RBI had cut interest rates
When I see a rise in the market rate on government securities, to me it shows that monetary policy needs to be loosened. It’s a signal. There are other signals which RBI will point to that credit is growing faster. RBI has to come to a conclusion.
Even if RBI cuts interest rates, what about the long-term interest rate which is influenced by government borrowing?
Everybody agrees that short-term rates will be affected by monetary policy. People argue that long-term rates are affected by the long-term fiscal deficit. But in the long term, we will get back to FRBM targets, which are still valid and we still believe in that.
How do you expect the economy to grow in fiscal 2009?
Before the beginning of the year, I gave a forecast of 8.5 per cent, plus or minus 0.5 percent, for fiscal 2009. When the commodity crisis hit, I changed it to 8 per cent, plus or minus 0.5 per cent. Why? Because the monetary action taken to control the inflation will affect the real economy. The third one we made was 7 - 8 per cent after the meltdown, so the response was to major events. The latest mid-year review, in December, was within this range.
For the next financial year?
I can’t give a forecast. At least six or nine months back, I said we expect the growth to be the same or higher. It will require an explanation, which I will do in two weeks time.
Last time round, the growth went as low as 3.8 per cent in 2002-03. Will the same repeat this time?
Agriculture was minus 7 per cent at that time. It’s (been) growing at 4 per cent in the last four years. We assume the long-term average in our forecast, which is 2.5 per cent for agriculture.
In the past 18 years, there were only two phases of high GDP years. Are we right in saying the trend has crossed a certain level when it is only in seven years that the economy grew at 7 per cent and above?
We addressed this in the Economic Survey, that the long-term trend is 8.75 per cent or 9 per cent. For a couple of years, we believe it will be below the trend growth.
What’s your view on financial sector reforms?
Capital inflows, which reached 9 per cent of GDP last year, was in a way very useful in sidestepping the limitations of the Indian financial system. Out of 9 per cent, 7.5 per cent went out again; 1.5 per cent remained in the economy. It made it easy for certain sectors of the economy, basically corporates, to access capital.
If you look at savings and investment in the economy, the gap was only 1 to 1.5 per cent. But the thing is that intermediation systems were not good.
You will not have a problem if you have the market. There will be enough savings in the economy, you do not need 9 per cent capital flows.
