The government has to choose in a trade-off between nurturing medium-term growth via cheap credit and compromising the political present if inflation persists
GDP growth as a metric of well-being has limitations unless supported by disaggregated data on where the growth happened, who it benefited and how many others lost out. Shorn of these statistical add-ons, GDP growth data provides guidance only at the broadest level of the national economy, and, that too, without accounting for the negative growth from degradation of natural resources.
It is, however, of great interest to governments because the quantum of revenue collection increases with growth and achievement of its fiscal stability metrics—the fiscal deficit or of public debt outstanding—improve, since both metrics are a proportion of GDP.
Also perversely, short periods of containable inflation help the government’s report card by enhancing revenues, because taxes are, mostly, though not all, collected as a percentage of the sales or production value of the good/service or on income levels. The spectacular 37 percent increase in Union government tax revenue till October 2021 is partly on account of tax collected on higher prices of goods/services and higher taxes on petroleum products, till recently.
Short periods of containable inflation help the government’s report card by enhancing revenues, because taxes are, mostly, though not all, collected as a percentage of the sales or production value of the good/service or on income levels.
Inflation, if accompanied by depreciation of the nominal exchange rate by the RBI adjusting for inflation differentials between India and the target foreign currency, can also keep exports competitive and imports more expensive, thereby, protecting high domestic value-add industry from imported competition, which aligns with the objective of Atmanirbhar (Self Reliant) Bharat.
But extended periods of high inflation wreak havoc on the poor, whose incomes are not indexed to inflation, unlike government servants who are 100 percent indexed and highly skilled professionals or businesses, who can pass inflation through to their customers, though it could come at the cost of decreased demand in a price sensitive market like India. Farmers also face inelastic demand for their produce and either absorb the price rise or pass on only as much the market will bear.
Government programmes also suffer from inflation impact. All of capital investment and around one fourth of revenue expenditure is funded from debt. Loans taken need to be larger to account for the higher costs along with the recurrent burden of higher repayments and interest cost.
Inflation also pushes up budgetary outlays without a necessarily corresponding increase in the outputs or outcomes for two reasons – sticky wages and monopolies (as in marketing of agricultural products sought to be ended by the, now repealed, Farm Laws) and low levels of real competitive pressure in the economy.
Loans taken need to be larger to account for the higher costs along with the recurrent burden of higher repayments and interest cost.
Inflation (consumer price general index) higher than the norm of 4 percent—such as we have been experiencing since October 2019—peaked at 7.6 percent in October 2020 during the worst phase of the pandemic but has abated since then to 4.3 percent in October this year. Going forward, rationalisation of the tax on petroleum products should restrain price pressure. But much is dependent on the continued normalisation of the global and domestic economy—a factor dependent on how pandemic dynamics play out with respect to the corona variants—earlier Delta and now Omicron.
Growth has picked up because the force of the pandemic has relented due to the diligently pursued, massive public vaccination program – a never-before effort achieved through close collaboration between the public and private sector.
GDP (constant terms) in the first half of 2021-22 (April to September) is higher than in the same period last year (2020-21) when GDP was 16 percent lower than 2019-20, the pre-pandemic year. However, it remains 4 percent below the outturn for the first half of 2019-20. Can the hole in output, created during the pandemic, be filled up over the second half of this year reverting us to the end-of-year GDP level of 2019-20?
The RBI expects India to grow by 9.5 percent this year as does the IMF projection for 2021, although the latter institution might downgrade global growth, earlier assessed at 5.2 percent for 2021 and 4.9 percent for 2022, depending on the pace of disruption due to COVID-19 variants.
Going by growth expectations, GDP by end of March 2022 could be INR 148 trillion, around 1.6 percent higher than the GDP of INR 145.7 trillion in 2019-20. India had already recovered to 2019-20 levels, in the second half of last year, with GDP around 1 percent higher. This is good news. But this also means that the growth rate will now slow over the coming two quarters Q3 and Q4 of the current year to between 3.5 to 4.5 percent because of the higher base effect. Why is that?
GDP (constant terms) in the first half of 2021-22 (April to September) is higher than in the same period last year (2020-21) when GDP was 16 percent lower than 2019-20, the pre-pandemic year.
Recovering lost GDP is like filling in a hole, which takes effort. But not as much effort as is required for taking the GDP to never before, higher levels, which is like climbing an unscaled mountain. The effort looking ahead is to go beyond the last recorded pre-pandemic growth level of 4 percent in 2019-20, which is far off the mark from high, single digit growth, particularly since even the global economy is set to grow at around 5 percent in 2021.
To be sure, large parts of the global economy and India, particularly in the “high contact” services sector, are struggling. Public expectations of improved economic circumstances are moderate at best. Unseasonal rains have damaged the kharif crop potentially diminishing rural incomes. The COVID-19 variant, Omicron, threatens continued economic disruptions. It imposes the administrative load of a fourth round of vaccinations, when only around 33 percent of Indians have been fully vaccinated (2 doses) versus 44 percent globally and the third round of a booster dose has yet to officially begin. This is despite achieving 1.26 billion doses by (December 3, 2021) with a current run rate of over 7 million doses per day.
It is not plain sailing on the economic front, either domestically or with respect to the global economy. The consequences of the liberal pandemic support globally have been an uptick in global inflation with surges in money in circulation. India, in contrast, was very fiscally prudent and reduced the budgeted fiscal deficit (FD) this year, in nominal terms, from INR 18.5 trillion or 9.5 percent of GDP last year to INR 15.1 trillion or 6.8 percent of GDP this fiscal. Till October, only 36 percent of the FD envelope was utilised versus expenditure budget execution of 52.4 percent.
The consequences of the liberal pandemic support globally have been an uptick in global inflation with surges in money in circulation.
The political difficulty in reigning in inflation through tight budget constraints are well known with significant elections in seven states around the corner. But the last thing any government would want is raging inflation impacting income-constrained voters. It is a trade-off between nurturing medium-term growth via cheap credit and compromising the political present if inflation persists. Political objectives trump economic prudence in all democracies. India is no exception.
The FD limit could also be breached if the uptick in revenue collection (71 percent of the budgeted amount till October) is not sustained. This year’s revenue receipts till October – despite low disinvestment proceeds – is a substantive INR 12.6 trillion, around one third higher than in the same period last year. The budgeted target for dividends and profits from investments in the public sector was overachieved at 114 percent by October end, thanks to a generous annual surplus transfer of INR 0.9 trillion, 73 percent higher than last year, by the Reserve Bank of India (RBI). Aggressive tax policy on petroleum products also helped, albeit diluted now. This trend in revenue collection augurs well unless reinstated economic constraints to manage attacks by corona variants dull the pace.
The government is clearly pulling out all the stops and innovating on the move, as the situation evolves. The problem goes beyond just having the funds for growth. The RBI has already liberalised access of foreign investors to designated government securities up to 6.5 percent of aggregate government bonds outstanding, with the hope of future inclusion in international bond indices. Current foreign holding is just above 2 percent. China has 9 percent of its government bonds held by overseas investors. But it also runs a trade surplus, unlike India, where a negative current account deficit (the difference between export and import of goods and services and technology payments) of 1 to 2 percent of GDP is par for the course.
The budgeted target for dividends and profits from investments in the public sector was overachieved at 114 percent by October end, thanks to a generous annual surplus transfer of INR 0.9 trillion, 73 percent higher than last year, by the Reserve Bank of India (RBI).
Three policy actions can help. First, prioritise capital investment over revenue expenditure to assist revival in growth momentum. Sadly, budget execution by October end of 46 percent in capital expenditure versus 54 percent in revenue expenditure, does not align with this objective.
Second, a deep dive into the growth potential of approved public investment projects is necessary. Adding a compulsory growth filter to project proposals, the results of which should be publicly available for independent analysis, could help eliminate “political pork” and preserve funding for the most economically rewarding projects.
Third, avoid a knee jerk, data driven, reaction to persistent price pressure driven by supply chain constraints. There is little option except to continue the “accommodative” stance in monetary policy, till we have decisively filled in the GDP hole inherited from the pandemic and have scaled new mountains.
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Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...
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