GS-III: Governing India through fiscal math

Context

While it is important for a government to pursue a sound economic policy, including management of the public finances, it is yet another matter to make a fetish of any one aspect of it. The latter appears to govern this government’s approach to policy when the fiscal deficit is given pride of place in its self-assessment.

Thread of fiscal discipline

• Soon after the Budget for 2019-20 was presented, one of the Finance Minister’s predecessors remarked that “fiscal prudence rewards economies”.
• It figured in the most recent Economic Survey, and its anticipated magnitude for 2019-20 was the final statement in the Budget speech that followed.
• The Finance Minister commenced the speech by saying how the government was committed to fiscal discipline.

Fiscal discipline

• In this context, “fiscal discipline” is understood as taking the economy towards the 3% of the gross domestic product.

Actually, the point is two-fold:

• Whether the fiscal deficit should be the sole index of fiscal management.
• What a reduction in the deficit would achieve?

Overall imbalance in the Budget –

• The fiscal deficit reflects the overall imbalance in the Budget.
• Embedded in the accounts of the government is the revenue account which is a statement of current receipts and expenditures.
• A fiscal deficit may or may not contain within it a deficit on the revenue account, termed the “revenue deficit”.
• The possible embeddedness of a revenue deficit within a fiscal deficit muddies the waters somewhat.
• For movements in the overall, or fiscal, deficit by itself tell us nothing about what is happening to the revenue deficit.
• A revenue deficit implies that the government is dissaving.

Rewards yet to be seen

• A revenue deficit of the Central government is relatively recent, having been virtually non-existent till the 1980s.
• After that rampant populism has taken over all political parties, reflected in revenue deficits accounting for over two-thirds of the fiscal deficit such as the case today.

Implications of Revenue deficits

• Revenue deficits have become structural in India by now.

This has three implications:

• That the public debt is only bound to rise.
• We are permanently borrowing to consume.
• Leaving it to future generations to inherit the debt.

International borrowing

• In the last Budget, the government has signalled its intention to borrow in foreign currency from the international market.
• This is an innovation alright as the Government of India has so far never borrowed in the international markets, leaving it to public sector organisations and the private corporate sector to do so.

Justification of the move

• In the Budget speech of the 17th Lok Sabha, the Finance Minister justified the move in terms of the very low share of foreign debt to GDP.
• The proposal has received criticism, some of it focussing on the consequences of exchange rate volatility.

Concerns with it

• Benefits have been flagged too, such as that Indian sovereign bonds will attract a lower risk premium because the price of the foreign-currency-denominated sovereign bond will now be discoverable.
• This though ignores the biggest lesson from the global financial crisis of 2007, that the market cannot be relied upon to price risk correctly.
• Dollar-denominated debt has to be repaid in dollars.
• Right now our reserves are fairly high but this could change.
• Oil prices could go back to where they were, the trade war initiated by U.S. President Donald Trump holds little prospect for faster export growth, and portfolio investment may flow out.

Conclusion

• In the final analysis though, it is not the risk of exchange rate depreciation or stagnant exports or even capital flight that is the issue it is the rationale for borrowing.
• With revenue deficits the overwhelming part of the fiscal deficit, we would be borrowing to finance consumption.
• Dollar denominated sovereign debt is just a matter of shifting this borrowing overseas.