Over the last few years, policymakers have stubbornly focused on achieving set targets in three areas—fiscal deficit, inflation, and the rupee exchange rate. In normal times, this discipline would be laudable. But with a slowing economy, perhaps it’s time for the government and the Reserve Bank of India to cut themselves some slack. A little bit of constructive indiscipline, if you will.
This, of course, is a novel situation. It’s not often that one has to tell policymakers they are taking their targets too seriously. The issue is usually the opposite—criticism that their attempts to meet targets are too lax.
Yet, both the government and the RBI are currently so focused on their respective targets that they are losing sight of the fact that some flexibility might actually be a good thing.
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Fiscal prudence with room to spend
The government has for a few years now committed to bringing down its fiscal deficit to 4.5 per cent of GDP by financial year 2025-26, which starts on 1 April. It has made considerable progress toward this, with the fiscal deficit target of 4.9 per cent for the current year likely to be met.
Now, there’s no doubt that fiscal discipline is a good thing, and it’s nobody’s suggestion that this prudence be thrown out the window. But given that the government has demonstrated it can be disciplined—bringing the deficit down from 9.5 percent in 2020-21—there’s certainly scope for some leeway in the upcoming year.
Why this is important is that, since the COVID-19 pandemic, it has been government spending that has propelled the economy. Consumption has been volatile—first, urban consumption bounced back from the pandemic decline while rural consumption suffered, but now the reverse is happening due to a decent monsoon but simultaneous high inflation.
Private investment, the other engine of the economy, has been chugging along at a tepid pace for many years now, a problem that predates the pandemic by nearly a decade. Exports, too, are hostage to global uncertainties, especially since India has not yet established a comparative advantage in anything other than services.
This shows up in the data, with merchandise exports remaining relatively sluggish but services exports doing quite well.
This leaves the last engine, which is government capital expenditure. So far this year, for reasons not entirely clear, the government has been going remarkably slow on its capital expenditure. The capital expenditure of the central government was about 12 per cent lower in the April-November period of this financial year as compared to the same period last year.
Finance Minister Nirmala Sitharaman had said the slowdown in government spending in the first quarter of this financial year was due to the national elections. Fair enough. But why has there been a slowdown since then?
One credible answer is that the government is concerned about its finances, and wants to meet its fiscal deficit target of 4.9 percent this year and 4.5 percent next year. However, as Soumya Kanti Ghosh, chief economic advisor to the State Bank of India, pointed out in an interview to ThePrint, the government could stagger its fiscal consolidation plan.
Perhaps it can try to achieve a fiscal deficit of 4.7 per cent next year and use the balance either to boost capital expenditure or provide much-needed income tax relief. Either way, a single-minded attempt to hit a particular fiscal deficit target isn’t helping matters.
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RBI’s targets are missing the point
The other two issues—of inflation targeting and the rupee exchange rate—have to do with the RBI. Of course, there’s no formal target for the rupee’s exchange rate, but the way the central bank been selling dollars from its reserves—about $60-75 billion in just a few months— to slow the slide in the currency’s value suggests there’s some internal metric at play.
Now, the RBI still has huge reserves, with the latest data putting them at $625 billion. It can certainly afford to intervene some more. But should it? The rupee is going to depreciate anyway. This is throwing good money after bad.
Also, if high reserves are a good thing—as the government and the central bank tom-tommed when reserves hit $700 billion a few months ago—then why are policymakers okay with squandering them on a losing cause?
The RBI should let the rupee fall or rise as it must, as determined by market forces. Here, too, a target (even if it is not explicitly stated) is not helping.
On inflation, the RBI did well by giving itself a band. It said that the inflation target was 4 per cent, with a leeway of 2 percentage points on either side. So the effective ‘comfort band’ was 2-6 per cent. This gave it quite a lot of flexibility. The problem is, it hasn’t taken advantage of this.
Time and again, former RBI governor Shaktikanta Das asserted that the RBI was focused on bringing inflation down to 4 per cent, even though it had been within the comfort level for months. Leave aside the fact that inflation had been elevated due to food prices, which the RBI couldn’t do much about in any case. Even then, it didn’t cut interest rates, despite growth flagging alarmingly.
So, what’s the point of giving yourself a band if you’re only going to target a single point?
The RBI is set to revise its inflation targets in March this year. Perhaps it needs to narrow the band—say, to 3-5 percent—but also treat any inflation within this range as acceptable. That is, it shouldn’t stop itself from imposing growth-boosting rate cuts if inflation is within this band.
Moving away from doggedly pursuing single data targets will allow both the government and the RBI to make the policy decisions that can propel growth. That is the priority right now.
TCA Sharad Raghavan is Deputy Editor – Economy at ThePrint. He tweets @SharadRaghavan. Views are personal.
(Edited by Asavari Singh)