Can the finance minister pull it off?

Sitharaman is the first economist in charge in the North Block after Manmohan Singh. She earlier assisted Arun Jaitley, as he piloted many of the Narendra Modi-led Union government’s big-ticket proposals such as the goods and services tax (GST), the one rank, one pension (OROP) scheme for the armed forces, the decontrol of petrol and cooking gas prices, land acquisition amendments, consolidation, recapitalization and privatization of public sector banks, and the laws for tackling black money, insolvency and bankruptcy code, and the inflation-targeting framework for monetary policy.

Some of these proposals went through; some stalled. Several of them had support from reformers, while some were outright populist. The reality of how political considerations throw economic policy out of gear would have been hard for Sitharaman to miss even as a minister of state.

No country or finance minister was prepared for the covid-19 pandemic. Economies that are bouncing back owe the recoveries mainly to fiscal excesses financed by loose-money policies of their central banks. The challenges Sitharaman is up against are more complex; there are no easy or obvious solutions.

India’s economy is stuck in three broad types of difficulties. First, the slowdown that precedes covid-19 and has proved intractable. Second, the legacy structural imbalances in growth and development due to which a small section of the economy performs well but the rest of the population struggles. Even in the high-growth years, not enough quality jobs get created. Third, the severe impact of the pandemic. The government, keen to underplay the pain and damage, is pushing optimistic recovery projections, but the economy isn’t out of the woods yet.

Economists, such as in the National Council of Applied Economic Research (NCAER), say that even in the best-case scenario, the economy will return to the pre-pandemic growth path only by 2029-30. If corrective steps are not taken, the economy can get into a downward spiral, leading to socio-political chaos. Can Sitharaman repair the economy and pull off a sustained recovery—something no Indian finance minister could do in the last 10 years?

FM’s response

Economic revival is contingent on the severity and duration of the unfolding health crisis. While how the coronavirus will behave cannot be controlled or predicted, the minister’s decision to provide the funds required for mass vaccination from the Union budget can help the economy immensely. If the vaccination procuring and administration agencies act quickly to inoculate a critical mass of the population, the need for stringent lockdowns will reduce, the damage to lives and livelihoods will be less debilitating.

The covid-19 pandemic has hit India hard. It has hit poor Indians harder. Surveys of food insecurity during last year’s lockdown collated by Jean Dreze and Anmol Somanchi show that between 50 and 80% of households surveyed were eating less than before. Further, an estimated 230 million Indians have been pushed into poverty, reversing the gains made in past decades when poverty rates in India had halved. The unemployment rate is up sharply. Household borrowings have increased. Incomes have reduced.

The finance minister has responded sparsely to this demand-side shock. It’s clear that providing relief, beyond token cash transfers and free food grains, is proving tricky. A lifeline for many, these measures are not to be scoffed at. But they don’t go to the heart of the problem the minister must solve: the investment rate has to be increased substantially for higher growth and jobs creation. Without this, even if consumption revives a bit as the vaccination drive picks up, the lost incomes and employment will still constrain aggregate demand, which was anyway low before the covid-19 outbreak.

The Union budget’s allocations for capital expenditure reflected the hope that public investments will pull in private investments. But these are not normal times. The uncertainty about consumer behaviour continues to keep private sector investment plans on hold. Captains of industry want the government spending taps opened. Uday Kotak, ex-president of the Confederation of Indian Industry (CII), said in May that the time has come for the government to stimulate the economy. Economists across the board are also saying that government must find ways to spend more.

The finance minister’s response came last month. She announced a stimulus mini dose, which has become like her trademark. The direct stimulus in the package adds up to 0.5% of the gross domestic product (GDP), insufficient to trigger new investments. None of her ‘Atmanirbhar’ packages so far will do much to address the key challenge that will define Narendra Modi’s prime ministership in the long run: the jobs crisis. Her targeted credit schemes, including for small borrowers, will become—inescapably—NPAs (non-performing assets) creating schemes. There are fundamental problems with the thinking behind them: how can government guarantee private debt? Loans are contracts between borrowers and lenders. Why should governments enter into contracts between two parties? The government’s role is to ensure robust regulation and functioning of credit markets. These schemes are further evidence of growing confusion about government’s role in a market economy that has come to characterize the Modi government’s policies.

The global economy is reviving, opening up a window for exports to again become an important engine of growth and employment creation. But India’s increasingly protectionist trade policy lowers the shutters on even that source of demand. The finance minister, inscrutable for her personal view of the back-peddling on market reforms, is toeing the line prescribed by the government and party leadership. Throwing her lot with the lazy lobby justifying protectionism, she has been hiking import tariff rates. Even prime minister Narendra Modi’s most ardent supporters, such as well-regarded economist Arvind Panagariya, have gone vocal on the dangers of this policy U-turn in a manner not seen in the last three decades since 1991.

The government’s allergy to advice from professional economists, especially those with experience of tiding over crises and deep understanding of the economy, is the finance minister’s singular disadvantage. A finance minister can be only as good as the tools and levers at their disposal. The Reserve Bank of India (RBI) governor has proved to be a great ally, as was expected, but monetary policy is not helping. The finance minister is holding on to the purse strings, as the fiscal space available is limited. True, the legacy fiscal structural constraints making her choices difficult were created by her predecessors. Overhauling fiscal policy is a tedious task even in normal times. Restructuring expenditure, widening the tax base and increasing non-tax revenue are messy and difficult decisions that can make finance ministers unpopular. No one likes to rock the boat. But someone will have to if the economy is to be steered out of prolonged stagnation.

Desperation for revenues

India collects far less in tax revenues as percentage of GDP compared with other emerging market economies.

Just ahead of the 2019 elections, Sitharaman’s predecessor Piyush Goyal made annual incomes of up to ₹5 lakh tax-free. Few countries peg their income tax threshold generously at roughly three times the per capita income. In one stroke, he let go of 13 million taxpayers. The tax net shrank so that of the total individuals who file returns, 63% don’t pay income tax at all. Rationalising government expenditure was difficult even in the pre-pandemic years, as it brings the finance ministry into confrontation with vocal interest groups that draw power and influence from the allocations they receive from the budget.

Not that Sitharaman is shy of fighting battles. She may not be ready to mend the fiscal deficit at this point, but she has placed her bets on privatization. Her scheme for reviving the economy rests—critically, many would argue—on privatization sales going through. Her calculation is that privatisation sales will yield the money for her to spend her way out of the crisis. She has also increased the budget’s reliance on excessive taxation of petrol and diesel which pits her against common people and betrays lack of imagination and tact. It is fuelling inflation. It is not a long-term solution to the structural problem of deficient tax revenues and is giving her the public image of being unsympathetic to household budgets.

Her ambitious plans for selling languishing public assets are clearly born of the desperation for revenue. Reduced role of government in the economy is not the prime goal. Anticipating resistance from employee unions, the finance minister has secured the surprise transfer of the department of public enterprises to finance ministry, showing quiet determination. Last, the A.B. Vajpayee government sold a few state-owned companies after which privatization came to a halt. What aces the finance minister has up her sleeve to break the spell promises to be interesting to watch.

Inflation woes

Who has the finance minister’s trust? Predictably, Reserve Bank of India (RBI) governor Shaktikanta Das, old North Block hand.

The Modi government confuses great rapport between an RBI governor and finance minister to be an indicator of healthy fiscal-monetary policy coordination. The two sides are of course cosy under Sitharaman and Das but the monetary-fiscal policy mix is far from optimal. The fiscal crunch, particularly when seen relative to tax collections and government expenditure, is approaching alarming proportions, increasing the finance ministry’s dependence on borrowings. The public debt-to-GDP ratio is closing in on the 90% mark.

To help the government tide over the dire situation, the RBI has refrained from raising interest rates and has kept its liquidity policies ultra-loose. The story it tells is of supporting growth but it’s no secret that the government’s constraints are as much the driver of monetary policy.

The RBI has devoted itself unabashedly to the cause of keeping government’s borrowing costs as low as possible. The joke doing the rounds in North Block is that the RBI has transitioned from an inflation-targeting to a yield curve-targeting central bank. The party may not last long.

The money the RBI is creating is driving up inflation. The central bank is dismissing rising prices as ‘transitionary’ and is complacent about the monetary phenomenon that is fuelling inflation. In truth, massive surpluses are accruing to it from the hectic printing of notes that it is passing on as dividends to government. The cash-strapped minister is grateful for now, but rising prices may start biting soon, creating new macroeconomic and political pressures. Economy watchers have an eye out for how she will, if at all, reduce the over-dependence on monetary policy. Not all economists are warning of the possibility of stagflation—when inflation runs high and so does unemployment—but a few are. The fears may be exaggerated but it’s unlikely that the finance minister is remiss about the risks.

Arguably, a policy-maker career cannot chart a steeper learning curve than Sitharaman has had. Many of the troubles the economy is facing today started before she was named the finance minister. The investment and policy crises—the root cause of the chronic weakness in the economy—go back to 2012. The fiscal deficit has not recovered from the over-stimulation of the economy by Pranab Mukherjee. He also pushed public sector banks to lend liberally and go soft on loan defaults. Instead of the GDP, these policies fired up the fiscal deficit, inflation and NPAs of banks. Macroeconomic stability weakened, ultimately resulting in a run on the rupee. Next, P. Chidambaram sacrificed GDP growth for containing inflation and restoring macroeconomic stability but did nothing to bring the banking crisis under control or tidy up the retrospective taxation mess Mukherjee had created. Jaitley also did not have much success with these. He preserved macroeconomic stability but could neither hold out nor cushion the economy against the shock of demonetisation.

Sitharaman’s performance will be judged on how she opened up fiscal space for increased government spending without disturbing macroeconomic stability, and how she improved the quality of the expenditure.