The Economic Survey, tabled in the Parliament on Friday, has hit the nail on the head when it highlighted the most pertinent question finance minister, Arun Jaitley, will have to face when he presents the Union Budget 2016 on Monday—stick to the fiscal consolidation road map or relax the deficit targets to give room for crucial public spending to give a leg up to the economy.
“Public investment may need to be increased further to address a pressing backlog of infrastructure needs. Such an increase would merely return spending to its 2010-11 level of around 2 percent of GDP, well below the level in other emerging markets,” the survey said, pegging the 2016-17 GDP growth at 7-7.5 percent, nearly same as the 7.6 percent growth achieved for the fiscal year 2016.
To be sure, though the survey argues both the merits and demerits of strict fiscal consolidation, it seems to argue against the strategy of aggressive fiscal consolidation in the economy. It further argues that the time is ripe for a review of the medium term fiscal framework and says a medium-term perspective to expenditure planning is necessary. “This is because the current environment is fraught with risks, which threaten all the engines of India’s growth,” the survey says.
This is precisely where Jaitley’s dilemma lies.
There is immense pressure on the government to stick to fiscal deficit targets set at 3.9 percent this year, 3.5 percent in 2016-17 and 3 percent by 2017-2018. Given that the government is lagging behind the schedule on fiscal consolidation (it has already delayed the path by one year) and Reserve Bank of India’s warnings against a fiscal-deficit driven growth strategy, the Narendra Modi-government is under pressure to oblige to the earlier set path to lower the borrowing costs in the economy.
Also, failure to adhere to the fiscal consolidation path can irk the international rating agencies and, in turn, can have adverse implications on the credit profile of the country. But, if the government needs to achieve this, it will have to massively cut public spending, which is detrimental to the economy at this stage. That’s a risk Jaitley will have to take for the greater good in the long-term.
But, as the survey points out, the growth-scenario remains weak and the early shoots of growth are yet to take firm hold. Private sector investments are yet to kick off in a big way and banking sector is still reeling under the bad loan crisis. Clearly, there aren’t many options or Jaitley to choose from. The government will have to keep the spending momentum on.
In fact, in last years’ economic survey too, there was a strong pitch for the government to take the lead on the investment front, with the assumption that this will be gradually followed up by the private sector. But, private sector is still hesitant to invest heavily on account of both global and domestic factors.
The survey indeed notes that increase in public spending, coupled with the implementation of 7th pay commission in 2016-17, could swell the fiscal deficit of the economy. “As a result, achieving the original could prove difficult unless there are tax increases or cuts in expenditures. There is some scope to increase receipts from disinvestment and spectrum auctions to realize which will require effort,” it says.
The survey has identified the major concerns for growth in the short-term. “One of the most critical short-term challenges confronting the Indian economy is the twin balance sheet problem - the impaired financial positions of the public sector banks and some corporate houses. The twin balance sheet challenge is the major impediment to private investment and a full-fledged economic recovery," the survey said.
Corporate earnings have remained muted. In the December quarter, the topline earnings of 418 companies (BSE-500 index) announced their earnings slipped by 8.5 percent year-on-year. Besides the general slowdown in the economic activities, a weak export-sector and funding scarcity have impacted companies. The even bigger problem lies in the banking sector, where a substantial surge in bad loans (over Rs4,00,000 crore as at end December) have eroded the networth of state-run banks and compounded their capital requirement problem putting pressure on the exchequer. Government has to think of ways how to address the cracked twin-balance sheets.
If one reads between lines, the economic survey makes a visible case for government to focus on the quality of the fiscal deficit instead of blindly targeting a number. At this juncture, clearly, public-spending to push infrastructure and manufacturing growth is crucial to speed-up economic recovery eventhough Jaitley will have to settle for a slightly higher fiscal deficit target. It’s a tough call for Jaitley to take.
(Kishor Kadam contributed to this story)