My previous column warned about over-dependence on monetary authority to cure the ills of the economy. Should India revive private investment (by reducing interest rates), or boost exports (by managing the currency, or providing cheap export finance), or unfreeze credit availability for non-bank lenders (by injecting liquidity), or reduce non-performing assets (giving more indulgence to time limits)? All these are tempting solutions to current economic problems. Reducing over-dependence means recognizing, for instance, that private investment is not forthcoming due to fears of recession and falling aggregate demand. Credit to non-banking financial companies is frozen because investors have become extremely wary and nervous, and not because there isn’t adequate liquidity. Exports have stagnated not for want of cheap refinance or an over-valued currency, but because of other serious problems. For instance, India’s poor performance in garment exports is partly because our domestic mix of cotton versus synthetic fibre is out of sync with global fashion trends, which need a much higher share of synthetics.The effective cost of labour is lower in Bangladesh, which also has duty-free access to European markets. Bangladesh gets fabric at zero duty into from China, something that Indian manufacturers do not enjoy. For Indian exporters, meanwhile, getting goods and services tax refunds is still a problem, even if considerably reduced. Various industries face the menace of an inspector raj. One exporter of fresh snacks—which are shipped in super-cooled containers—was asked by customs officials to open a container for inspection; this meant that the consignment could not be exported since fresh produce loses value if taken out of refrigeration. This may or may not be an isolated example, but it does illustrate the hurdles in the ease of doing business.

The broader point is that curing economic ills will need non-monetary solutions as well. However, that does not automatically mean only a fiscal stimulus. The ghost of John Maynard Keynes readily makes an appearance, just like Hamlet’s father. However much Keynesianism is discredited, it gets reincarnated repeatedly because it holds an irresistible charm for policymakers and politicians. When chambers of industry issue a collective call for a fiscal stimulus, it sounds like the right thing to do in times of a slowdown. Spend more, give tax cuts and increase government procurement, all this is par for the course. But a more libertarian critic, or a student of Friedrich Hayek, would say, “We are basically saying, ‘Let’s spend other people’s money’." Incidentally, this year was the first that we saw Hayek quoted in the Economic Survey. In the 1970s, the name would have been taboo in India’s economic policy firmament. Not so in the present times of “minimum government and maximum governance".

It is a truism worth repeating that excess fiscal spending is like taking resources from tomorrow. There is a theorem in economics on this called Ricardian Equivalence, which says that when a government tries to stimulate an economy with debt-financed spending, people increase their savings since they figure that a higher deficit today would mean higher taxation tomorrow. So, fiscal policy has limited impact. Ricardian Equivalence has been tested empirically and the findings are somewhat mixed, although the fiscal multiplier is found to be low, confirming its basic insight.

The temptation to go more than full throttle on the fisc in the present circumstances has to be curtailed. Firstly, as was pointed out by a member of the Prime Minister’s Economic Advisory Council, there is some mismatch between the numbers in the Economic Survey and those in the Union budget. The actual revenues may be lower by 1.7 trillion, which means next year’s target is likely to be more than a herculean one. Secondly, the report of the Comptroller and Auditor General indicates that the actual fiscal deficit was 5.85% and not 3.46% of GDP last fiscal year. Thirdly, the combined borrowing requirements of public sector entities put together is close to 10% of GDP. This is almost equal to the savings of India’s entire household sector. This is a recipe for crowding out private borrowers. Last fiscal year, almost 82% of government debt was eventually held by the Reserve Bank of India, which is almost like monetizing the deficit.

In his last lecture, former deputy governor Viral Acharya highlighted the risks due to such crowding out. It has an adverse impact on corporate borrowing costs, financial stability, and the monetary transmission mechanism itself. India’s debt-service ratio puts it in an outlier group among peer nations. The urge to exceed the fiscal deficit may be encouraged by the new-fangled Modern Monetary Theory, which essentially says that fiscal spending does not cause inflation nor higher interest rates at a time when three-fourth of the sovereign debt in the developed world is fetching negative yields and the nominal GDP growth rate exceeds the nominal risk-free long-term interest rate. India should refrain from believing in this madness.

A more prudent approach is to fix issues of ease of doing business, carry out meaningful privatization, clear the government’s huge overdue payments (close to 10 trillion), and increase aggregate savings. Oh, also, maybe a very small increase in the fiscal deficit.

It’s going to be an uphill fiscal year.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution.

Close