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Photo: Reuters
Photo: Reuters

India should be mindful of the ill effects of a stimulus overdose

The Centre must resist the temptation of fiscal overspending in its quest for much higher growth

I was unable to understand a headline that dropped into my mailbox on the very first morning of the year 2021: ‘2020 ends on a sombre note for the economy: fiscal deficit hits 135% of budgeted estimate in 8 months of 2020-21’. Almost all commentators without exception had called for higher fiscal spending. So, the government’s deficit already being at 135% of the budgeted figure in the first eight months of the year must be, on balance, a good thing. Then, why the ‘sombre note’?

That headline is actually a warning to the government. If it ends up budgeting a fiscal deficit for 2021-22 that is rather generous, most public commentary would turn hostile and call it reckless, irresponsible and fiscally ruinous for the country, without batting an eyelid.

As of the first eight months of the financial year 2020-21, total revenues were around 37% of the budgeted revenues (tax, non-tax with the non-tax receipts, including privatization receipts, etc.). Now, if we optimistically double that percentage in the remaining four months of the year, total revenue realization would be 75% of the original budgeted receipt figure of 22.5 trillion—i.e. 16.85 trillion.

Total expenditure in the first eight months of the financial year has been 65% of the budgeted expenditure of 30.4 trillion. The government has said that total expenditure for the full year will be in excess of the budgeted expenditure. Let us assume that it would overshoot the budgeted expenditure by 10% to 33.44 trillion.

India’s nominal gross domestic product (GDP), as of March 2020, was 203.4 trillion. This is the most recent estimate that we have. Now, let us accept that nominal GDP will be lower only by 3% for the year. That would mean nominal GDP by March 2021 will be 197.3 trillion. (Parenthetically, the National Statistical Office projects a lower GDP number than this. )That would give us a gross fiscal deficit for the Union government of 8.4% of GDP for 2020-21.

Now, what should the government do in 2021-22? If it targets the same expenditure level (hopefully, it can do more capex which is not easy), what can be the revenue in a year in which the forecast is for a nominal GDP growth of between 12% and 15%?

I will take 13% nominal GDP growth (8% real plus 5% deflator rise) and a revenue buoyancy of 1.0. So, we can expect the Union government revenue to rise to 19.04 trillion. Nominal GDP will be 222.9 trillion in March 2021. So, the Union government’s fiscal deficit will be 6.46% of GDP.

That sounds easily achievable. But, let us remember that the government, right or wrong, is supposed to target a stable fiscal deficit of 3% of GDP. Assuming the current year’s final deficit ratio is 8.4%, the government could look at lowering it by about 2 percentage points with the unstated intent to achieve a bigger consolidation.

Why is it that the government could or should target, unofficially, a bigger fiscal consolidation? There is copious inflow of external capital. India’s equity markets are sizzling hot, as are many stock markets around the world. Earnings growth expectations for Nifty stocks are around 30% for the next financial year. Optimism reigns. If profit growth turns out to be as good as is expected now, India’s investment cycle will rebound. That does, at the margin, weaken the case for the government to add its own stimulus to an economic cycle that is likely to have revived strongly.

A likely revival in the investment cycle on the back of strong growth in corporate profits will be well supported by capital inflows from the developed world. Knowledge Leaders Capital, a US based investment advisory firm, wrote in July, “Within [emerging markets, or EMs], favour the countries that are the most pro-cyclical" and “...those with typically higher inflation and balance of payments deficits tended to do best in falling USD periods." Then, in October, economists at Goldman Sachs wrote (‘What’s in store for the dollar?’), “The negative relationship between the dollar and global growth likely partly reflects the effect of the dollar on global growth through its special role in trade, cross-border borrowing, and investor portfolios. The large downward move in the dollar that we expect therefore supports our above-consensus forecast for global growth, and particularly for EM growth."

Under these circumstances, compared to the situation some three-four months ago, the risk now is that the government overdoes its fiscal stimulus for 2021-22 rather than under-provides it. In this millennium, India committed the mistake of not consolidating its fiscal situation when animal spirits in the private sector were soaring. That was between 2003 and 2008. Then again between 2009 and 2012, the government failed to roll back its stimulus in time. To a large extent, the country is still paying the price for it.

The temptation to push for a much higher rate of growth when the going is good, and to clock possibly the world’s highest growth rate, will be irresistible. Further, there is ground to make up for 2020-21. But, ‘stronger for longer’ and ‘delayed gratification’ are more appropriate mantras for 2021-22.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views.

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