A balancing act

The govt should be flexible on the fiscal position

In some bad news for the fiscal situation, it has been reported that the excess of government expenditure over revenue in the period between April and October of the current year — in other words, the first half of the financial year 2018-19 — has already exceeded the budgeted fiscal deficit target for the entire financial year. The fiscal deficit target for the ongoing financial year is 3.3 per cent of gross domestic product, or GDP. This target already represents slippage from the previously declared path of fiscal consolidation. Though the government thinks otherwise, there are now very real fears that the target will be further missed. After all, this is also an election year, and many governments have opened the taps of populist spending in order to secure re-election. Slowing growth, stagnant expenditure, uncertain revenue, and populist pressures together make achieving the fiscal deficit target look increasingly unlikely.

Fortunately, inflation does not appear to have responded to this adverse fiscal position. It continues to be well below the Reserve Bank of India’s (RBI’s) target of 4 per cent, and was indeed 3.3 per cent in October. This reflects various aspects of the economy, including subdued farm prices. Over the past three months, global oil prices have also fallen by over 30 per cent. This has opened up a gap with the RBI’s current policy rate, and calls into question how long the RBI’s tightening stance will continue. The recent GDP numbers show that private sector investment is showing signs of life after a long period. But real interest rates continue to be high, given the level of inflation, and there does not appear therefore to be much hope for a pick-up in growth from that front. Yet there are good reasons for the RBI to be cautious. For one, it is not clear at all what the path of oil prices will be in 2019. The Organization of Petroleum Exporting Countries (OPEC) and its non-OPEC allies including Russia have met in Vienna over the past week and agreed to slash output in the coming year — which might mean that oil prices are on the way up again. Nor is it in any way certain that the exemptions to the Iran sanctions granted to China, India and Japan by the United States will be renewed when the time comes to review them after some time.

The path forward for the government is thus unclear. On the one hand, it cannot give in to populist pressures and turn up spending, given the fiscal difficulties it faces. On the other hand, the real economy is clearly showing signs of strain. The favourable base effect that flattered growth in the first half of this year will vanish, and so it is hard to imagine full-year growth coming in very much higher than 7 per cent. A focus on propping up farm incomes might pay electoral dividends and reduce rural distress, but at the cost of once again causing food inflation to become a structural problem. It is best, therefore, for the government to remain flexible on the fiscal position, and seek to ensure that non-tax revenue is high enough, while simultaneously looking for ways to raise animal spirits in the economy that do not depend upon big-ticket expenditure.