Mind that debt
Indian Express, 25 May 2009
The biggest challenge before Finance Minister Pranab Mukherjee will be how to prevent a fiscal crisis. Economic reforms, good governance, labor reforms and financial sector liberalisation are policies where business as usual may not be the first best, but it is possible to do nothing and go on as usual. On managing the fiscal situation business as usual could result in a fiscal crisis, a loss of confidence in the Indian government, capital flight and a sharp depreciation of the rupee. With the debt to GDP ratio at 80 percent, with no credible framework for fiscal consolidation, with the Fiscal Resposibility and Budgetary Management Act in tatters, the fisc is today in a very precarious position. Pranab Mukherjee has become Finance Minister when the world economy is in the wost recession since Indian independence, when domestic industrial production is falling, when exports are declining and when the RBI seems to believe there is no need for a monetary stimulus. But even if he were to provide no further stimulus, stabilizing the debt GDP ratio is not going to be easy.
So far, over the last one year, India has been very fortunate. The US and the UK have the priviledge of running high deficits and rising debt to GDP ratios and still retaining the confidence of the international community. India is a developing country and the rate of expansion of the deficit would have scared anyone. However, thanks perhaps to the long run India growth story, there has been no serious loss of confidence in India. As an emerging economy, however, we cannot take this confidence for granted. It has often been observed that a change in confidence is very sudden. At some point international debtors, as well as citizens, can lose faith in a government's ability to repay its debt. International experience shows that the proabability of default rarely rises slowly, it sees sudden jumps. Indian experience of 1991-92 was similar. When confidence fell, India was thrown into a crisis.
What is the likely scenario of deficits and debt in the coming months? The first important element in this story is that, tax revenue collection depends on production and income in the economy. With exports and industrial production having shown a decline since the beginning of this year, and with the gloomy trends in the world and domestic economy, it is likely that revenue growth will be low this year.
On the expenditure side, there is likely to be pressure to expand expenditure due to two factors. The first is counter-cyclical policy, that is, to provide a fiscal stimulus since the economy is witnessing a slowdown. The second reason for expansion would be large expenditure programmes. While the expenditure on the on-budget fertiliser subsidy and the off-budget oil subsidy may be lower this year due to lower oil prices, the salary bill of the government will be higher thanks to the implementation of higher pay scales and the arrears that have to be paid this year, interest payments will be larger due to higher borrowing as well as the rise in yields on government securities. In addition, if there is expenditure on infrastructure as planned and an expansion of the NREG, there is bound to be an impact on the deficit, leading to a higher debt to GDP ratio, which is already at 80 percent of GDP. If adequate care is not taken, this could lead to a sudden change in confidence about the Indian government's ability to pay back its debt.
It would be unwise for the new government to take the risk plunging into a fiscal crisis. But if it wishes to avoid it, what are the options before it?
One option is to increase the efficiency of its expenditure. It is well known that there is huge scope for both reducing expenditure and increasing its impact by making far reaching changes in the delivery mechanism of subsidies and local public goods like health and education. There is scope for reduction of food, fertiliser and oil subsidies without hurting the poor in any way. These reforms have been on the agenda for a long time and in the light of the present challenges it would be a good time to implement them. However, they will take time to implement, and they will not have immediate impact.
The second option before the government is to sell assets to retire debt so as to stabilise the debt GDP ratio at the present level and to prevent it from exploding. We know that at the present level of this ratio the national and international community has not lost confidence in India. Instead of taking the risk of letting this ratio rise owing to fiscal expansion in the coming months, it would be prudent to reduce the probability of such an event occurring by pre-emptively selling assets. These could range from the assets that are the easiest to sell, i.e. shares of listed public sector enterprises to more difficult ones like selling perpetually loss making public sector enterprises. For example, it could sell the top five loss making companies: Fertiliser Corporation of India, Hindustan Fertiliser Corporation, Bharat Coking Coal Ltd, Eastern Coalfields Ltd and National Jute Manufacturers Ltd. which have made losses year after year. Since each of these companies, and many more like them cannot be sold on the stock market, and have accumulated losses so large that no startegic partner will be willing to pay for them, the government needs to find a way to dismantle these companies and sell off pieces of them, such as the valuable land they might hold, to get some revenue. This revenue must then be used to retire debt.
The tension between a fiscal stimulus and fiscal prudence will be a tight rope walk in the coming months. Promises of welfare programmes in the Congress's manifesto clearly entail an increase in expenditure. Talk of a stimulus to prevent the global recession from hurting India might provide the background for further stimulus. The most difficult question facing Finance Minister Pranab Mukherjee is going to be: how far should he go in increasing expenditure in the coming budget?
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