No merit in continuing with dressed up numbers

Interview/ Montek Singh Ahluwalia, economist


The finance minister claims the economy is in recovery mode. Do you agree?

The economy is clearly recovering from the very sharp contraction caused by the lockdown. However, the pace of recovery remains uncertain and it is not even across sectors. Some sectors such as the MSMEs and the informal sector in manufacturing, and also the hotels, trade and travel sector remain badly hit. According to the CSO (Central Statistics Office), the GDP dropped by about 15 per cent in the first half of 2020-21, but performance is expected to improve in the second half, and the contraction for the year as a whole will be 7.7 per cent in real terms. This is better than was feared earlier, but it will still be the largest decline in any of the major developing countries.

Fixing the GST should have top priority. This was a major tax reform, but the way it was implemented has deprived it of its revenue generating potential.

The pandemic seems to be slowing down, which augurs well for the economy in future, but uncertainty remains because we cannot rule out (secondary) spikes as happened elsewhere and there is the possibility of new strains. However, the commencement of vaccination is a good development which, combined with continued vigilance on preventive measures, may encourage a faster return to normalcy.

Was the stimulus package announced during the lockdown a step in the right direction?

A stimulus was certainly called for and all countries did it. Our stimulus was a combination of credit relaxation measures and direct fiscal stimulus via additional expenditure, both together amounting to 10 per cent of the GDP. While this looks large, the pure fiscal component, was only a little over 1 per cent of the GDP.

I think we could have incurred more additional expenditure to support consumption levels of the poorest groups who were the hardest hit. The government probably hesitated because it feared that with revenues expected to collapse, the fiscal deficit would rise, and additional expenditure would worsen the situation. I recognise that fiscal discipline is important, but there are circumstances where one has to accept a higher fiscal deficit to get the economy back to normal. We can then reduce the deficit in subsequent years to restore fiscal stability.

Interestingly, the CSO’s expectation of an improved performance in the second half of the year itself depends upon the growth in government consumption being much faster in the second half than in the first. The finance minister seems to have realised this and she has said she is going to spend to bolster the economy. This is good, but had the same approach been displayed earlier, it would perhaps have stimulated a stronger recovery.

What steps should be taken in the budget to revive the economy?

We have to see the revival issue in two different contexts. One is the short term objective of recovering from the contraction in output in the aftermath of the lockdown. The other is the longer term objective of getting back to an acceptable growth trajectory once the short term recovery is achieved.

As far as the short term objective is concerned, I think if government expenditures are stepped up in the remaining part of the fiscal year as the finance minister has promised, it will put the economy in a position to recover strongly in 2021-22, bringing GDP in that year back to the 2019-20 level or a little higher. In other words, having contracted by 7.7 per cent in the current year, the economy could grow by 8 per cent or so in 2021-22.

The fiscal deficit in the current year will be much higher than the budgeted 3.5 per cent of GDP. It could be as high as 6.5 per cent of GDP, and this does not include off-budget items. Including these items could raise it to 7.5 per cent. Personally, I think this is an opportune time for the finance minister to reveal the full extent of the fiscal deficit (including off-budget items). There is no merit in continuing with dressed up numbers which everyone knows do not reflect reality. It is much better to acknowledge the facts and then try to present a credible picture of how we plan to get back to a better situation over the next few years.

If real GDP growth next year is 8 per cent or a little more, over the depressed base of the current year, this could mean growth in nominal terms of about 14 per cent, with a similar increase in revenues. This should make it possible to show an improvement in the fiscal deficit from 7.5 per cent in 2020-21 to say 6 per cent in 2021-22. This is still high, but I think weak demand conditions, especially uncertainty about the revival of private investment, justify avoiding a sharp fiscal contraction next year. A further reduction in the fiscal deficit to say 3 per cent could be planned over the next three years.

The challenge before the finance minister is not the achievement of a high growth in 2021-22. That will come simply because of the low base in the current year. The real challenge is how to get on a high growth path from 2022-23 onwards. We entered the pandemic with growth down to 4.2 per cent per year. Will the economy only get back to this sort of performance or can we get back to 7 plus per cent which we did achieve over a long period? I hope the budget for 2021-22 puts in place measures that will help get back to 7 plus per cent growth after the recovery is complete. That is the kind of growth rate we need if we want to generate employment in the economy.

What would you look for in the budget from that point of view?

The finance minister has consulted with representatives of different sectors and this would have thrown up many specific suggestions for change. However, these specific suggestions are typically less important than their advocates believe in determining the longer term growth outcome. I would look for some key reforms that will contribute to restoring faster growth over a longer period.

Structural reform in tax policy and tax administration, which would lay the basis for a robust growth in revenues, is an important area in which to act. India’s tax ratio is much lower than it should be, given our per capita income, and we cannot deliver the public services and finance the infrastructure development we need without raising the tax ratio.

Fixing the GST should have top priority. This was a major tax reform, but the way it was implemented has deprived it of its revenue generating potential. The agenda is well known: we need to bring into the GST the items that are still outside and reduce the number of rates. This can be done by drastically reducing the list of exempted goods, having a common rate of say 14 per cent on most goods, and a special higher rate of say 24 per cent on a range of luxury goods. The present rate of 28 per cent is too high and applies to too many goods including some that are intermediates.

These changes cannot be implemented through the budget and they have to be made by the GST Council. However, a clear statement by the finance minister indicating an intention to take the matter to the GST Council, combined with political effort to mobilise support from BJP-ruled states, should enable the changes to go through.

We also need immediate action to fix problems in the banking sector. There is no chance of strong economic growth if banks remain reluctant to lend despite high liquidity, because of their high levels of NPAs and perceptions of risk. The problem will intensify next year since many accounts are expected to turn NPA once the moratorium introduced to deal with the problems posed by the pandemic comes to an end. If recognition of NPAs is further delayed by regulatory forbearance, it will undermine the credibility of the regulatory system. If the new NPAs are recognised, banks have to make provisions to reduce their capital adequacy. This raises the issue of recapitalisation of the public sector banks which should be explicitly dealt with in the budget.