All governments tend to game their performance metrics. Smart governments guard against accepting the make-believe as real. The BJP stumbled in believing that India had earned an entitlement to grow, faster than China, at eight per cent per year. Well-intentioned measures — to end black money, resolve the stressed bank loans and reform indirect taxes added to the crowded agenda and disrupted entrenched business interests. Growth was bound to suffer because India depends significantly on private entrepreneurship and capital. The government does not have the luxury to cry over spilt milk. It needs to keep delivering public services. Implementing structural reforms — making labour markets less rigid, reducing the regulatory overburden on business and improving poor infrastructure, cannot be done within this year. We must, instead, look for the low-hanging fruit to maintain macro-economic stability this year in the hope of higher, even possibly eight per cent growth, in 2018-19. Suresh Prabhu, the new minister for commerce, just days into his job, is already evaluating possible incentives to kickstart export growth, which has languished since 2014. Realigning the Indian rupee to more realistic levels could be his best bet. INR was at '63.90 per US dollar four years ago, in September 2013.
Since then higher inflation in India versus the United States has eroded the real value of the rupee. The overvalued INR not only makes exports uncompetitive, it also makes imports cheap, which hurts domestic manufacturing, constrains new investment, inhibits growth and job creation. Of course, there are negative consequences of depreciating the rupee. A weaker INR and a higher than targeted fiscal deficit might induce a flight of foreign, hot money, anticipating higher inflation. But with inflation at historically low levels — the consumer price index below two per cent — and oil prices relatively stable, high inflation does not appear to be a near-term risk. More important, any slack due to the flight of foreign hot money can be mitigated by domestic investors with idle savings, desperately in search for rewarding investments. A cheaper rupee also has the virtue of discouraging gold imports, which have surged in recent months, by making gold more expensive, relative to the returns on financial investments. Another downside is that depreciating the rupee by nine per cent makes oil imports, consumed domestically, more expensive by around Rs 30,000 crores. Allowing this additional expense to pass through to retail prices can spur inflation. This means reducing the royalties, taxes and cess on petroleum. Also with slower GDP growth, the increase in the aggregate tax revenue will be lower. Growth was budgeted at 11.75 per cent (7.5 per cent real growth and 4.25 per cent inflation). The actual nominal growth may not exceed nine per cent (six per cent real growth and three per cent inflation). The shortfall against the target would be of around Rs 30,000 crores. This makes the total revenue shortfall around Rs 60,000 crores.
An additional uncertainty this year is that the Goods and Services Tax might reduce the net tax levels due to the new facility of netting-off taxes paid on inputs. This has caused a flutter in the first two month of July and August with 65 per cent of the GST revenue recorded being set off against input tax credit on pre-GST stock of goods. But fortunately, this possibility had been anticipated and factored into the rather conservatively targeted increase of 6.9 per cent for excise and service tax, whereas customs and income-tax revenue were budgeted to grow by 11 per cent and 20 per cent respectively over the previous year’s collections. Consequently, the risk of GST collecting less than the targeted amount is minimal. The targeted revenue deficit (RD) is already 1.9 per cent of GDP versus the maximum permissible under the Fiscal Responsibility and Budget Management Act of two per cent of GDP. This limit reduces the scope for borrowing, to fill the revenue shortfall, to around Rs 16,000 crores. It would increase the fiscal deficit (FD) from the targeted 3.2 per cent of GDP to 3.3 per cent of GDP — not a very significant departure and still considerably better than the FD in 2014-15 of 4.1 per cent of GDP. Also, there is no shortage of liquidity in the domestic market, so the government can borrow without crowding out the private sector.
The binding constraint is that hefty cuts in revenue expenditure amounting to a hefty Rs 60,000 crore will be needed to maintain the RD at two per cent of GDP. A targeted approach could be to reduce non-merit subsidies. These include LPG and kerosene subsidy in urban areas. The differential between rural and urban wages should enable urban residents to pay for clean, commercial energy. Reducing the subsidy on urea (Rs 50,000 crores) is an environment-friendly option. The department of expenditure has expertise in identifying and cutting fat budgets. Barring defence, security, social protection, human development and infrastructure, significant reductions in budgeted revenue expenditure are possible to keep the revenue deficit at below two per cent of GDP, as targeted. Balancing the budget judiciously merely manages the negative outcomes of low growth. Removing constraints on exports can add to growth. Similarly, addressing GST glitches and minimising the compliance burden can significantly improve business sentiment. Notwithstanding our administration being colonial in structure, it works quite well under stress with targeted, short-term deliverables. Achieving six per cent growth this year, with fiscal stability, is one such challenge.
