Trying to blend the best of policy advice and market wisdom is never easy. However, at the moment, a couple of questions are plaguing most people – should the government abide by the fiscal deficit, where should it spend to pump prime the economy, where can it raise resources and what tax growth can it assume, and finally what will qualify as a great Budget.
Professor Govinda Rao, one of the best minds on public finance and more importantly Member of the 14th Finance Commission, in principle does not believe that India needs to stick to 3.6 percent fiscal deficit. However, he quickly adds, considering that household sector’s financial savings are just about 7 percent of GDP – if the Centre and the states end up with fiscal deficit of more than 6 percent of GDP, where is the money available for the private sector to make investment and how can the Reserve Bank of India (RBI) reduce the rates of interest.
Dr Subir Gokarn, former deputy governor RBI and now head of research, Brookings Institution, says it is important that the government signal its commitment to fiscal consolidation and hence not deviate from the numbers. At the same time, finance minister Arun Jaitley needs to find ways to finance and get the infrastructure sector back on track.
Sajjid Chinoy, economist with JPMorgan India and also Member of the Urjit Committee or the panel on monetary policy framework too believes it is important to stick to 3.6 percent. He says the more fiscal consolidation there is, proportionately more room for monetary easing opens up.
Neelkant Mishra, Director, Credit Suisse India too says savings from oil itself can be more than one percent meaning higher excise duties and subsidy savings. “I think that government does have room to spend even if they don’t expand that 3.6 percent ratio,” he says.
Below is the verbatim transcript of Govinda Rao, Subir Gokarn, Sajjid Chinoy & Neelkant Mishra’s interview with CNBC-TV18’s Latha Venkatesh
Q: Is it important to stick to that 3.6 percent given fiscal deficit number or can the government take liberties?
Rao: I do not support that in principle because as it is in this country, 36 percent of the general revenues go into servicing the debt paying interest payments. If you go on adding to debt like this, there is no way you can do any development activity in the future. Quite apart from that, at a time when the household sector’s financial savings are just about 7 percent of GDP – if the Union and the states end up with more than 6 percent of GDP of fiscal deficit, where is the money available for the private sector to make investment and how can the Reserve Bank of India (RBI) reduce the rates of interest? So there are issues of that nature.
Q: Is 3.6 percent supposed to be sacred, can the Finance Minister take some liberties?
Gokarn: I think it is very important for the government to signal a complete commitment, a firm commitment to fiscal consolidation so the numbers should not be deviated from. However, what it means to do then which I think addresses your second question, is he needs to find other ways to finance what is clearly the most pressing, the most threatening need of the economy, which is how to get the infrastructure sectors back on track and so the challenge is yes, confirm to fiscal discipline but then be innovative about how to get money for infrastructure.
Q: Do you think the government will seriously compromise if it went 3.9 or 4 percent kind of a fiscal deficit, will it make the RBI’s position very difficult, which side of the fence are you?
Chinoy: I have been in a camp that if you go back to the last 10 years in India and you talk about the rules versus discretion debate on fiscal monetary policy, it is very clear the rules have won out. When you stuck to fiscal discipline in the mid-2000, there greatly re-enforced macro stability. When we went off that part in 2008-2009, we all know what the macroeconomic consequences were.
So I think it is important to stick to 3.6. The finance minister had an opportunity in July to veer away and to his credit, he stuck to 4.1 percent and reiterated his desire to stick to 3.6 percent and 3 percent. That was the time when oil was at USD 100 per barrel. The fact that India is benefiting from massive fiscal savings with oil being close to USD 60 per barrel, our estimates are somewhere 0.6 percent of GDP in fiscal savings next year becomes very hard to justify as you now have 0.6 percent of savings that you didn’t know about in July, you committed to a number in July and now you are going to renege on that commitment.
So I think for those reasons alone, 3.6 percent is important. From the monetary policy perspective, it is very clear, it has been over the last decade, Dr Gokarn was on the hot seat when this happened. The more fiscal consolidation there is, proportionately more room for monetary easing opens up. It stands to reason and I think the governor has been quite clear that high quality fiscal consolidation is an imperative for more easing.
So I think for a variety of reasons, it would be important to stick on the part of the roadmap that has been adhered to for the last two years.
Q: Where would you stand, you speak to a wide swathe of foreign investors, will a reneging on 3.6 percent be taken badly or will faltering on growth be taken even worse?
Mishra: I think that 3.6 percent, if they deliver on that, would be the third lowest fiscal deficit in 35 years. The government of India doesn’t – we are too enamoured by western frameworks, we have to pretty much chart our own path. The government of India plays a very important role in the economy. We are not as well structured or developed as some of the western economies are. In fact, I think given what the President Obama is doing as well, now we need to see fiscal stimulus coming through in many of these governments because the private sector is pretty much shut down in terms of investment.
I think in India as well, the problem is that the near-term economy is doing bad. Cement demand being down 10 percent year-on-year (Y-o-Y) very weak base, steel demand being very weak, everything seems to be slowing down sharply. I think the government needs to step it up a bit.
Taking up from what Sajjid Chinoy was saying there is – and our estimate of savings is significantly higher, I think the savings from oil itself can be more than one percent meaning higher excise duties and subsidy savings. I think that government does have room to spend even if they don’t expand that 3.6 percent ratio but I won’t be surprised. Looking at comments from investors, I would say that most investors won’t be very negatively inclined to seeing higher fiscal spend. I think what they will be more interested in is the nature of the spend, what is it being spent on and secondly, the duration of the spends. If it is a 12-months, 18-months stimulus I know that it is usually when you start spending, it is very hard to withdraw but if it is nice, short 12-18 months stimulus, spent appropriately, I don’t think investors will pan the Budget.
Q: Let me get one more issue out of the way, even as we have to pump prime, there is another big issue that can come to crimp the government and that could be what the finance commission is likely to say. Do you think that in the process of having to spend, the government will first of all have less money because it has to transfer more money to the states because of the finance commission’s diktat?
Rao: If you recall, last year when the medium-term fiscal plan was put out by the government, it said finance commission’s recommendation could be a downside risk. Apart from that, I cannot say what the finance commission has said because I was the party to the finance commission’s recommendations but the basic issue there possibly is that you will have to closely look at the huge expansion that has taken place in the transfers to the states in terms of the centrally sponsored schemes particularly in the areas, which belong to the state. The constitution has union list, the state list and the concurrent list and in the state list, I think it is best left to the states to do what they want to do rather than going on telling them what they should do and how they should go about doing it.
Q: The other side which the government can use is obviously to cut expenses, if you can give us some idea of how much the government can save purely because of Aadhaar based distribution of subsidies and what are the other pockets, low-hanging fruit it has to cut revenue expenses?
Gokarn: I cannot put a number on it. I was also a part of the commission that made recommendation. So those are presumably being considered. However, the general principle that is now universally accepted is that there will be some very quick short-term pay-offs to a transition to Aadhaar as a basis for delivery of not the subsidies but all kinds of benefits. So the Direct Benefit Transfer (DBT) framework is now entrenched and it is a matter of rolling it out, it is a matter of expanding it, it is a matter of monitoring it and ensuring that it was reaching the beneficiaries.
So the short-term benefit as many people have pointed out is from simply what is called the duplication or removing claims from the system and that could add up by some very preliminary estimates to about 10 percent of the total value of the expenditure. That is substantial saving. The government cannot give up on its commitment to infrastructure.
It has become completely unchallengeable that if the government does not put money into infrastructure, infrastructure is not going to move anywhere. There isn’t any capacity to private sector to fund the kind of requirements that we have. So taking this off the Budget, I think is the big challenge and how do we take it out of the Budget while you firstly take infrastructure out as far as possible out of the ministerial domain and put it into what I would considered to be a reasonable model, which is a national investment fund or national infrastructure fund, which is what I have been advocating and use that as a sort of venture capital framework if you will put in some money from the Budget, get money from outside but always spent it against specific assets. That is how a company does investments, the government should be starting to do this.
So I think the separation between what the Budget typically consists off which is revenue expenditure funding to keep government going and funding the asset formation. I think we need an innovation in terms of how we separate the two and that is what is going to get us the combination, the balance between fiscal discipline, which is on the conventional Budget and capacity to pump prime, which is to get moving on this whole range of infrastructure project that are stuck and that is going to hurt the economy in terms of growth prospects over the next few years if the problem is not addressed.
Q: Lay out the math for us. Where can the government find the money to pump-prime the economy?
Chinoy: We have all said that the big theme from this Budget is going to be greater public investment and I agree with Neelkant that the fixation from foreign investors will not be so much but whether the fiscal deficit is 3.6 or 3.9, the heavens won’t fall if it is 3.9 as long as people are convinced that those extra resources are being used for significant public investment on the balance sheet.
My own sense is that the composition of spending has become very adverse. Capital expenditure of the Budget which used to be two percent of the GDP rose to above three in the mid 2000s is down to one percent of GDP. Now, there are limits to how much you can ramp it up so, in my estimation given state capacity, given implementation capacity, I would like to see another 0.5 percent of GDP in higher capital expenditure whether it is railways or highways this year and you need to find that space. We have all said that a subject not spoken about is bank retail capitalisation; that is going to be equally important to make sure there are enough funds to recapitalise public sector banks to break the logjam in that sector.
I would argue over last year another 0.3 percent of GDP and then of course you have the fiscal reduction, the deficit of 0.5 percent. So, the way I look at it, what the government needs to do is find about 1.3 percent of GDP in fiscal space this year to achieve both objectives, higher investment and a lower deficit.
0.6 or 0.7 of that have already come – manna from heaven, it is oil subsidies. I have been arguing for long time that the government should do an asset swap. Very similar to what Dr. Gokarn said that sell assets more aggressively and reap those resources and plough them directly into asset creation, so it is an asset swap on your balance sheet. If you can get 0.4 or 0.5 percent more in non-tax revenue from asset sales, that just leaves you to find about 0.2 percent of the GDP. It cuts another expenditure; subsidies for example to square the math. Let me end by saying that this is the first full Budget – people are looking for a vision; they are going to look for a paradigm shift on higher infrastructure spending, a direct benefit transfer (DBT) road to subsidies over the next three years, more recap funds for banks and so if that paradigm shift is achieved, I am not sure they will be too fussed about 3.6-.3.9 though for me the perfect Budget is to achieve both objectives simultaneously; more public investment and still adhere to your fiscal target.
Q: You are becoming a bit of a fence-sitter. Neelkant, where should it be spending, what is the best way to get a good multiplier?
Mishra: It is very difficult for the government to spend. They have not spent for so long; they have lost the institutional capacity to spend. So, when we were doing our math and we figured out that there is about one and a half lakh crore that possibly the government can spend, we started thinking through okay, so what can they spend on? The first thing that we came to was okay maybe national highways and then you look through the numbers, it is 10,000 km, Rs 70,000 crore over three years, that is 23-25,000 crore. They already spent 11,000 so there is another 15,000 crore gone.
Railways, they give 30,000 crore, maybe they can make it 50,000 crore, but the railways has an institutional problem in terms of being able to ramp up very fast and then you are suddenly left wondering, okay so what else and then you necessarily have to encroach on state subject so, there is a whole wide swathe of things that they can do. Generally a prescriptive research is terrible for investors when you are turning your hopes into forecasts. It is very tempting but one should avoid doing that.
So, what we have done is use five juristics that the government may think important. The first as you said is the multiplier. You cannot just buy solar panels that won’t have much of a multiplier. You would need to be in short cycle projects because you can’t be committing to a high fiscal deficit forever. You need to have shovel ready projects, you can’t be doing river interlinking and bullet trains. You need to adhere to the manifesto and you need to invest in areas where there is institutional capacity to ramp up very fast.
So, as I said railways traditionally you would think it is a bottomless pit, that it is always starved of funds, if you give them one lakh crore they can spend it but they cannot spend very fast because one, they have not been spending for a while and two, there is the institutional bureaucracy that has to go through it. The best way to spend and this is where I am really doing prescriptive stuff so the chances of going wrong are very high is they should spend on housing and they should spend on rural roads because one, these are things and especially the housing given what China went through over the last five years, the aftermath is a bit undesirable but if you go from three trillion to nine trillion GDP, having three bad years after that is not that bad an outcome.
Similarly, the US 2001-2006; now the US model was clearly too risky, ninja loans and all that. The Chinese model of state investment in low cost housing was actually perhaps not something that will work in India. So, an interest subvention on 15 lakh or sub 15 lakh houses, construction tax, service tax waiver on construction, possibly even a capital gains tax waiver and suddenly thousands of contractors all over India’s towns become active. You start seeing demand for cement and steel. Similarly rural roads, the way things work or even rural housing, Indira Awaas Yojana (IAY); you can name it whatever you want but if you give 15,000 crore, you build one house a village, you give 45,000 crore you build three houses a village. There is leakage but that leakage again gets spent in the economy, does not go to a Swiss bank account. So, rural roads, rural housing, urban housing would be the best way to stimulate the economy.
Q: One word on what you would consider a great Budget, which number percentage of capex to total GDP, what will be your definition of a good Budget?
Gokarn: Three things; one is a theme, a kind of a vision, a road map for the next five years or four years, whatever is left of the term in terms of budgeting process. We need to know now what the government is thinking of over the next three years. We do not want to see or I would not want to see a one-off budget, a one year Budget with no sense of a longer term commitment. Second, we have talked about expenditure reform, reducing subsidies and bringing technology as much as possible into the delivery and monitoring of subsidy and welfare schemes and third very importantly keep to the deficit but take the cap spending, the capital expenditure of the Budget, put it into a firm balance sheet and that means creating a new institutional mechanism to do that. We should not be mixing capital spending which is critical with fiscal consolidation which is equally critical; we have to find a way to separate the two.
Mishra: Much more streamlined expenditure for the states, so really the spirit of federalism. It could be much fewer Centrally Sponsored Schemes (CSS) and also a capex to GDP which could be going up from a non-defence, going from one to maybe two, two and a half percent of GDP.
Chinoy: Three very quick numbers tactically. I would like to see the fiscal deficit adhere to 3.6. The state does not have the capacity to increase non-defence capex from above one to one and a half. So, anything above that would be unrealistic and third on revenue side, let’s finally have realistic tax to GDP assumption. So, if you get realism on the tax GDP ratio, you get a capex number of one and a half and you get a 3.6, that would for me be the best of all worlds and that is possible a) because of the windfall savings from oil and b) with a little bit of boldness in creativity on the asset sale front so, that for me would be the perfect package.
Q: Dr Rao very quickly you definition of a good Budget?
Rao: I would call a Budget -a good Budget – one, where you have substantially, in fact you have adhered to the fiscal targets that have been set. You have not done some creative accounting or spill; you have not done spilling over of the expenditures in to the future or taken advance taxes of the next year and you have substantially pruned your revenue expenditure so that quite a lot of it goes for the capital expenditure and the capital expenditure ratio substantially increases.