Sajjid Chinoy, chief India economist at JPMorgan.
Sajjid Chinoy, chief India economist at JPMorgan.

Centre has shown admirable fiscal restraint in the budget: Sajjid Chinoy

JPMorgan’s chief India economist Sajjid Chinoy talks about the maiden budget of finance minister Nirmala Sitharaman and the pros and cons of the measures announced in the budget on the macroeconomy

NEW DELHI : Sajjid Chinoy, who is currently JPMorgan’s chief India economist has previously worked at the International Monetary Fund (IMF) in Washington DC and was a senior associate at McKinsey & Co. in New York. He also served as a member of Reserve Bank of India’s expert committee to revise and strengthen the monetary policy framework that proposed inflation targeting in India. In a telephonic interview, Chinoy talks about the maiden budget of finance minister Nirmala Sitharaman and the pros and cons of the measures announced in the budget on the macroeconomy. Edited excerpts:

At a time growth has actually slowed down substantially to a five-year low, do you think the budget has taken enough measures to revitalize the economy?

The budget had to perform a delicate balancing act. On the one hand, there was a need to provide the economy with some impetus, since output gaps have clearly opened up, but on the other hand, there was absolutely no fiscal space to work with. This is because total public sector borrowing requirement (PSBR) of the Centre, states and public sector undertakings (PSUs), it is already between 8-9% of the gross domestic product (GDP), and is consuming virtually all household financial savings. Given this starting point, any fiscal expansion would have been counter-productive by pushing up bond yields, credit spreads and undermining the Reserve Bank of India’s (RBI’s) monetary transmission. Against this backdrop, the budget has done the right thing by showing admirable fiscal restraint. I have no doubt that the Centre will stick to its fiscal deficit target of 3.3% of GDP in 2019-20. But it’s equally important that this is achieved without adding to off-balance sheet borrowing, particularly on the subsidy front. If the PSBR does not further increase this year, it will go a long way in lowering interest rates in the economy. Conversely, if the Centre keeps to its deficit target but PSBR increases, government bond yields may come down, but credit spreads will go up because of the increased quantum of quasi-sovereign issuance. All told, however, the budget’s fiscal restraint is admirable, amid growing call for a fiscal stimulus.

The fiscal restraint is of course admirable. But are the policy measures taken in the budget enough to boost the economy?

There are at least two measures that will help growth. The fiscal restraint has meant that monetary transmission has improved with bond yields already falling 40-50 bps in just the last two weeks. So, the cost of capital has come down and we expect this process to continue, with more monetary easing expected. Therefore, one way growth will get a fillip is through a lower cost of capital, helped by fiscal restraint. Second, the government has allocated 70,000 crore for bank recapitalization, and we expect at least half of this to translate into “growth capital". This will release the capital constraint faced by some public sector banks and therefore boost credit growth, at a time when there is increased substitution away from NBFCs (non-banking financial corporations) towards PSBs. However, it’s important that this capital be allocated meritocratically (the better governed banks get more) so that there is no moral hazard. Second, it’s critical that governance reform of public sector banks accompany recapitalization, so that the higher credit growth does not lead to another NPA problem down the line.

Are you saying because there is no fiscal space to revive growth, that heavy lifting has to be done by monetary policy now?

That’s right. Given the starting points, tighter fiscal-easier monetary is the right mix. The starting point for fiscal is so unfavourable that there was never any space for a fiscal stimulus. In contrast, with core-inflation softening so appreciably, and headline inflation expected to stay below 4% for the foreseeable future, some space for monetary easing has opened up. Ensuring the PSBR does not increase further, and more explicitly linking small-savings rates to market benchmarks, will result in better transmission of monetary policy.

So is a rate cut in the August monetary policy committee (MPC) meeting a sure thing now given the fiscal restraint shown by the government?

With the growth slowdown showing no signs of abating—the June PMIs were the weakest in 13 months, auto sales remain soft, and global growth momentum is slowing sharply—and headline inflation on course to remain below the target of 4%, we expect the MPC will cut rates again in August.

The budget proposal of an overseas sovereign bond has invited a lot of criticism. What are your views on it?

With domestic savings under pressure and capital around the world looking for productive use and yield, it’s understandable why policymakers would want to attract more foreign savings to augment domestic savings and so, apart from the sovereign bond, there are various initiatives in the budget to attract more FDI (foreign direct investment) and FPI (foreign portfolio investment) inflows. As regards the bond, I expect the maiden issuance to be very well subscribed, because there will be a novelty and scarcity premium attached to it. Going forward, however, we should continue liberalizing the domestic currency bond market, so as to attract more FPI inflows into the domestic market, and eventually become part of a local currency bond index, as other large emerging markets have done. This will attract sticky, real money; ensure FPIs, and not the sovereign, bears the currency risk; and ensure greater regulatory control.

More generally, attracting foreign capital inflows is important. But excessive reliance will put upward pressure on the exchange rate which both complicates monetary management and becomes a headwind to boost export growth. As the Economic Survey correctly argued, exports need to be the lynchpin of an 8% growth strategy in the coming years. So, policymakers will have to strike the right balance between relying on foreign capital and maintaining a competitive exchange rate to boost exports, and be careful about not accentuating the “trilemma".

Do you think the tax revenue growth assumptions in the budget are credible?

To achieve the budget targets, gross tax collections for 2019-20 will need to grow at 18% over what was actually achieved in 2018-19. This compares with a growth of gross tax collections of less than 9% last year, so achieving budgeted targets will not be easy. To be fair, tax collections will benefit from the increase in personal/customs/excise increases. But even adjusting for these changes, gross taxes will need to grow at about 16% on a nominal GDP growth of 11%. The presumed tax buoyancy is therefore 1.5 in 2019-20 versus an achieved buoyancy of less than 1 last year. This will take some doing. What policymakers need to prioritize is simplifying GST (goods and services tax) compliance while significantly tightening GST enforcement. If you look at the last three years, the pressure has squarely been on indirect taxes which have fallen from 5.6% of GDP in FY17 to 5% of GDP in FY19. So boosting GST revenues is the key through increased compliance.

The other debate that the budget has generated is about the surcharge on the income tax paid by the rich as it also extends to the FPIs. What are your views?

It is understandable that with revenues under such pressure, the government was under pressure to raise tax rates. And the theory of progressivity would argue for increasing tax rate of those at the very top. However, public finance theory also tells us that the incidence of tax should be greater on factors of production that are less mobile to achieve greater efficacy. Going forward, therefore, we need to be mindful that if we tax factors of production that are mobile and can travel across international jurisdictions, tax rate increases may not result in commensurate revenue increases, because compliance rates fall.

The other highlight of the budget is the credit guarantee it has announced for NBFCs. Do you think that’s a good measure?

I think it is intended to be a very targeted and temporary measure to reduce risk aversion among banks and induce liquidity to flow back to the NBFC sector. While this measure is worth trying, if its efficacy is limited, we may have no choice but to eventually undertake an asset quality review. This is because the issue in the NBFC sector is not on the liability side, it’s on the asset side. In our view, because of the asymmetric information about the underlying asset quality of NBFCs, lenders cannot distinguish bad apples from good apples, and aren’t lending to any apple. That’s the current market failure that will need some regulatory intervention.


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