Fiscal policy needs to be tightened at Centre, state-level in next financial year to avert growth drag
A step back from fiscal rectitude at this point will exaggerate the uncertainties around the fiscal outlook for the medium term.
Government will surely be keen to include some election sweeteners and rural incomes and small businesses have emerged as the key themes
Any meaningful expenditure package will, however, face funding problems
A step back from fiscal rectitude at this point will exaggerate the uncertainties around the fiscal outlook for the medium term
Spending more and running higher deficits to help small businesses or rural economy can prove counterproductive
Budget traditionally covers the government accounts of the year gone by, as well as its plans for the year to come. In an election year, it is not a regular budget because the government seeks re-election in a few months.
Convention dictates that the next finance minister gets to make the final decisions about expenditure after a new government is formed and thus ‘interim budget’ replaces the annual Union budget in general election years.
Typically, the ‘interim budget’ thus gives only an update on the current fiscal. For the Budget 2019 to be presented on 1 February, however, all signs point towards announcements of ambitious spending plans anyway.
‘Interim’ or not, it is thus important to put this budget in context. With growth concerns emerging in some pockets of markets, higher government spending will push up consumption and alley growth worries in short-term.
Besides, even though it could potentially be superseded by a new budget presented by the incoming government, it gives a sense of the likely fiscal package if the current government were to remain in power.
Most importantly, with the fiscal maths getting tricky for the current year and next, borrowing plan for the next fiscal year will alleviate uncertainties surrounding the bond market currently.
Given that Budget 2019 is the current regime's last one ahead of the general elections, populist undertone is almost a given. Government will surely be keen to include some election sweeteners and rural incomes and small businesses have emerged as the key themes.
Union Minister Arun Jaitley has already hinted that “…., may go beyond a mere vote-on-account as tackling agricultural challenges……..that "can't afford to wait"…..even at the risk of breaching the fiscal deficit target”.
Over the past few weeks, government’s support to small enterprises and low-income households has already been ramped up. With signs of rural distress gaining steam and farm loan waiver emerging as key factor in recent state elections, ambitious expenditure programme for rural India and continued support for small businesses are likely to continue as important themes.
Any meaningful expenditure package will, however, face funding problems. It is in this context that the number that will draw the most attention from markets is the fiscal deficit.
As things stand, hitting the target of reducing the central fiscal deficit to 3.3 percent of GDP in the current fiscal already looks virtually impossible. Recent expenditure announcements, in absence of new revenue will make it harder to achieve fiscal consolidation objectives.
Agreed that some notable offsets could help, but the most likely fiscal outcome for the year now appears to be upwards revision of the deficit target for current fiscal, while a smaller deficit target is set for the next financial year. Bond yields have already risen significantly over the past month in response to growing evidence of missing fiscal targets.
A step back from fiscal rectitude at this point will exaggerate the uncertainties around the fiscal outlook for the medium term. To meet the public debt-to-GDP ratio target of 60 percent by FY25, the Centre and the states would need to double the efforts to lower the overall fiscal deficit over the next seven years and tax revenues would have to rise faster than nominal GDP growth for the next six years — an almost impossible scenario.
Such uncertainty around meeting fiscal targets will in turn have implications for bond yields, sovereign ratings, economic growth and stability.
From the economy’s perspective, fiscal deficits are a guide to whether government borrowing is crowding out the private sector as a destination for savings. Spending more and running higher deficits to help small businesses or rural economy can prove counterproductive via higher borrowing costs in medium term.
It also brings forth the choice of short-term impulse to growth against a sustainable growth path. A moderately positive fiscal impulse in short-term on back of government expenditures will recede quickly once the election has passed.
Given the tight fiscal space, fiscal policy will have to be tightened significantly at both Centre and state levels in the next financial year and overall fiscal policy will turn into a drag on economic growth after the election.
Thus, while the build-up towards the general election has impelled considerable fiscal and policy commitment towards certain sectors and it will support consumption demand in the near-term, these reflationary responses do not last long and the same fiscal factor could quickly turn to be a growth drag.
The Budget 2019 thus faces the impossible task of meeting the conflicting demands from political, economic and market perspective.
(The writer is economist, RBL Bank)
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