The demand for a fiscal stimulus in India is emerging from various quarters.
But unlike governments of the advanced economies, which have significantly stepped up spending, India is being, and has to be, more cautious. Considering the uncertainty about the evolution of the novel coronavirus, the possible need for further lockdowns, and the expected decline in tax revenue, the Indian government is being sensible.
Economic growth and tax revenue this year is uncertain. Financing the budgeted expenditure of Rs 30-odd lakh crore estimated in the Union Budget, and the announced Covid fiscal package, will be a challenge. It is being argued that spending on welfare measures should be increased significantly, by 5 per cent of GDP.
This year, tax revenue may fall. Borrowing beyond the Rs 8 lakh crore on budget and the off-budget borrowing that was already in the works will be more difficult if domestic savings decline this year. Those advocating that the government spend more need to ask: Where will the money come from? What are the estimates for domestic savings? Even if India prints money, thereby imposing an inflation tax, do they want it to be more than one or two per cent of GDP?
Foreign borrowings can also only be maybe a per cent of GDP higher, and that is if growth remains in positive territory.
Fall in tax revenue
Even though the lockdown in India started on 25 March, GST revenue was sharply down in the month. Collections in March 2020 were 4 per cent less than in March 2019. Revenue from import of goods was 23 per cent less, and the total GST revenue was 8 per cent less than March 2019.
When GST data is published for April, the first month of the fiscal year 2020-21, it will no doubt be worse, as April was a month of full lockdown.
The budget estimate of tax revenue for 2020-21 — Rs 16.3 lakh crore — was already an ambitious target over the previous year’s revised estimates of Rs 15 lakh crore. It was based on a nominal GDP growth projection of 10 per cent made before Covid-19 hit India. After the entry of the virus and the lockdown, nominal growth and tax collections may be lower.
With the economy even in partial lockdown, there will be a decline in the production, trade and consumption of goods and services. This means that there will be a fall in tax collection, both direct and indirect taxes such as GST, custom duties, income taxes and corporate taxes, and in disinvestment proceeds.
The government, therefore, cannot afford to go on a spending spree at this time of the year. The situation is different from a post-Lehman bailout of banks in the US, where it was a one-time big fiscal expenditure. The uncertainty surrounding the evolution of the coronavirus and the economy has made leaders cautious, and rightly so, because they do not know how much spending and borrowing may be required during the course of the year, or how much revenues may fall.
From whom will the government borrow?
The government normally borrows from households and firms through various intermediaries like banks, life insurance, small savings, provident funds, and the bond market.
The hit to incomes could mean people save less to survive. They may borrow or dip into assets. The household sector consists of not only households but also household enterprises, or small firms. With lower production and sales, domestic household savings may decline.
At the same time, domestic corporate savings going into paying wages and salaries and higher inventories in the period of lockdown would also result in lower corporate savings. This would mean less domestic savings are likely to be available for the government to borrow from.
There is an argument that the decline in discretionary expenditure, such as on weddings, cinemas, restaurant meals, holidays, etc. will go down, and thus push up total household savings. But even if discretionary expenditure declines, the overall effect on savings will depend on how people’s jobs and incomes fare in 2020-21.
To a small extent, the government can impose an inflation tax by printing money. But beyond that, it may have to borrow from abroad, if domestic savings fall with falling incomes. For this, India’s public debt must be on a sustainable path, and credit rating must not suffer.
When most of the world is in recession and markets are looking for safe places to invest, India could be an attractive destination. Government of India bonds can be a relatively safe asset. India has already declared its intention to be part of global indices that will encourage portfolio investors to come to India.
India has also changed the caps for foreign investors, to encourage more investment in rupee-denominated Government of India bonds.
To be able to attract foreign investment, India’s credit rating has to remain high, and the country should not be considered below investment grade, or thought of as a “fragile” economy. India’s macroeconomic stability will be of primary importance.
Inflation has to remain low, interest rates low, and growth positive for public debt should be on a sustainable path. Strong fundamentals will boost confidence in the rupee.
This is a period of high uncertainty, and global pools of liquidity can be highly volatile in such periods and go into “risk-on, risk-off” mode, and start moving to US bonds and exit emerging economies when the risk perception in international money markets is high.
Any emerging economy seen as riskier is likely to see more capital flight when a shock hits global markets. We saw this in May 2013 with Bernanke’s taper talk.
India is currently in a reasonable place. The government is seen to be fiscally prudent. In addition, inflationary expectations are anchored. The slowdown in demand, the low oil price and our commitment to low inflation will keep the external balance and the rupee stable.
The government is being sensible by not increasing expenditure by lakhs of crores in the very first month of the fiscal year. It does not know what lies ahead.
As an economic revival strategy, it is better to try to restart the economy along with stringent safety rules and tight containment zones, and reduce the damage for firms and households so that they require less support, than to try to push through large very fiscal packages and end up in a macroeconomic crisis.