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Photo: PTI
Photo: PTI

Opinion | A fiscal strategy for India in the deficit-stimulus gap

India needs a new narrative to address concerns of a likely ratings downgrade due to fiscal slippage

What a difference six months can make. Consensus seems to be building that the economy needs government intervention to tide over the slowdown. This is a complete U-turn from sentiment prevailing even six months ago when there was unflinching belief that low interest rates alone could hoist a $2-trillion economy out of an economic morass. In the midst of this new-found realization, there is one small matter that must be tackled first: finalizing the grand strategy or narrative for life after fiscal stimulus.

Some ground realities first: it’s not as if the government has been tight-fisted all this while. In fact, government expenditure is responsible for whatever growth is witnessed during this economic slowdown. Gross domestic product (GDP) data for the July-September 2019 quarter—which printed at 4.5%, the lowest in 25 quarters—shows that among all the engines of growth, government expenditure grew the fastest, thereby pulling up overall growth considerably. The fact is this engine alone has been powering India’s growth story for the past few quarters. Some of the government’s expenditure compulsions can also be attributed to unending electoral cycles, which need to be lubricated through regular resource transfers.

One obvious question is how to finance the fiscal stimulus. There are no easy answers but a couple of short-term and long-term solutions are already available. It is also nobody’s case that the government should re-allocate its budgeted spending, first between revenue and capital expenditures, and then even within the two heads to improve quality of spending. For example, the government’s revenue expenditure strategy, especially for FY20, seems more focused on finessing the electoral cycle than rejuvenating and sustaining economic growth. Second, the Centre should transfer states’ share of revenues without delay because it is affecting the states’ spending, which account for almost 50% of spending in the economy.

In an interview to this newspaper, Reserve Bank of India governor Shaktikanta Das said revenue accretion will be important for implementing a fiscal stimulus programme: primarily through disinvestment and through better tax collections, especially by plugging loopholes. Certain ministers and government officials have even said that the government will look to address problems at the sectoral level rather than spray-paint with scarce resources.

While the final contours of the government’s fiscal stimulus strategy will be unveiled on 1 February, it is now certain that the fiscal deficit target set under the Fiscal Responsibility and Budget Management Act will be breached. This is not a big deal: the Act allows for slippage in times of crisis. But a major worry emerges from across the shores: whether a fiscal slippage will lead to an adverse rating outlook or, worse, a rating downgrade.

Here is where India needs a new strategy or a fresh narrative. International credit rating agencies have already served notice on India, stating unequivocally they won’t take kindly to any fiscal slippage. Moody’s has already changed India’s rating outlook to “negative". Standard and Poor’s has also issued dire warnings about lowering India’s credit rating if growth does not improve.

It is unlikely that the rating agencies will concur with the necessity of a counter-cyclical fiscal stimulus. The leading western rating agencies display a home-country bias and seem hostage to outdated economic orthodoxies. In a paper on sovereign credit ratings (bit.ly/35K7Owp), economist Carmen Reinhart has shown that sovereign rating downgrades tend to be relatively higher for emerging market nations. In short, credit rating agencies tend to display pro-cyclical behaviour when rating sovereigns. “Rating agencies have tended to focus on the ‘wrong’ set of fundamentals. For instance, much weight is given to debt-to-exports ratios—yet these have tended to be poor predictors of financial stress," she concludes in her paper.

The Indian political executive and economic administration have been extra sensitive about the ratings of these agencies. Given the trade slowdown and the need for foreign investment to manage the current account deficit, concerns over India’s sovereign credit rating make sense. But these are crunch times and require differentiated solutions. Sorting out the crisis should take precedence over what rating agencies will do. In any case, they’ve been inflexible even during India’s high-growth years. Given their alacrity in upgrading some of the crisis-hit European nations, it is difficult not to detect a certain bias in their methodology.

There’s another strategic piece worth understanding. Sovereign ratings appeal largely to bond and equity portfolio investors, whose investment decisions currently seem to be driven more by different global risk-on considerations than sovereign ratings. And so, even if rating agencies change India’s ratings outlook or the rating itself, it is unlikely that global investors will rush for the exit. At least, that is what they seem to be indicating in private meetings.

Herein lie the seeds of India’s strategic moves: helping global investors keep their faith. This can be achieved by re-building trust. One, the government must clearly communicate its glide-path back to fiscal discipline. And, for this to be taken seriously, the government will also have to start improving the quality of data it releases.

Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal

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