Headline : What a well-aimed fiscal stimulus could do for India Livemint Editorial 4th Dec’19 Livemint
Need for fiscal stimulus to revive growth:
- It is clear by now that India needs a large dose of fiscal stimulus to rev up the engine of growth.
- Everyone is looking forward to India’s Union Budget that will be presented in a couple of months.
However, size of the fiscal stimulus is constrained by risks to flow of international funds into India:
- The size of the stimulus will be determined by constraints on borrowing capacity, debt servicing and concerns about India’s sovereign rating.
- A ratings downgrade (due to breach of fiscal deficit targets) would increase the cost of borrowing not just for the government, but for the private sector as well.
- It could also trigger an automatic freeze on portfolio funds that passively follow indices and have been investing hugely in India. Such a freeze could in turn strain the rupee’s exchange rate, which might fall abruptly.
- The risk of a sudden stop or reversal of international flows is very real, and cannot be ignored by our fiscal managers.
- This happens as India cannot trade in its own currency:
- Negative fallout from certain fiscal decisions is the price India pays for not being able to pay for imports in one’s own currency.
- Foreign inflows are necessary, at the very least to pay for imported oil and capital goods.
- Since dollar earnings from exports are not enough to cover the country’s trade deficit, the dependence of currency stability on the fiscal situation cannot be emphasized enough.
- Some space available for rupee to weaken:
- There is, however, space for the overvalued rupee to weaken, say up to a level of 75 to the dollar, but not beyond, and certainly not abruptly.
- A weaker rupee acts as a sort of stimulus to domestic manufacturing, especially the small and medium enterprises reeling under the onslaught of cheap imports.
But not all fiscal space is lost as FRBM Act allows breaching fiscal deficits if growth is well below potential:
- While keeping an eye on the above vulnerabilities, not all fiscal space is lost, and certain fiscal measures can still be effected.
- For a start, if the economy’s growth rate is 2.5 percentage points below India’s potential, then there is an escape clause even from the Fiscal Responsibility paradigm to pump in money.
- FRBM actually focuses on a steady decline in debt levels—as a percentage of GDP—to sustainable levels, rather than getting fixated on a fiscal deficit ratio.
- In that sense, it may be possible for the Budget to propose a deficit of 3.5% or 3.8% of (GDP) – a deviation from a path proposed in past years (to get the deficit to 3% of GDP or lower).
Possible fiscal measures to force a way out of the current tough economic situation
Higher fiscal deficit:
- For fiscal policy to be effective, it has to be countercyclical.
- In this context, a higher deficit in a recession-like year is okay.
Drive consumption in lower-strata through income transfers:
- Every precious extra fiscal rupee obtained by running higher deficits should lead to an immediate boost to consumption and growth.
- For the short term, there is a need to find ways to directly inject that fiscal rupee into the pockets of consumers—preferably from the lower-income strata, since their propensity to spend the money will be the highest.
- This could be in cash or kind. It could even be an enhancement of the rural job guarantee scheme, which also serves as proxy unemployment insurance.
- In the medium to long term, the corporate tax cut will help increase consumption and employment.
Capital gains tax should continue:
- Despite demands from certain sections, there is not need to give up the capital gains tax.
- The stock market is at an all-time high, clearly negating the view that such a tax hurts investor sentiment.
- India is a similar position to that of most jurisdictions that do not have zero-tax treatment of capital gains.
- These are direct taxes which are progressive because they impact the rich more than the poor, and technology has made them easier to administer.
- India’s direct tax to GDP ratio is among the lowest in the world, and we cannot afford to give up a well-justified direct tax.
Bringing in digital tax:
- The time has come for India to consider a digital tax, similar to that of France (also floated by the OECD as a global anti-base erosion tax).
- Apple, Amazon, Google, Facebook and Microsoft, the world’s five most valuable firms, have a substantial user base in India, but not even an iota of their prosperity is shared with Indian users.
- While in the long term the idea to get them to list on Indian stock exchanges can be considered, in the short term, we need to have a small digital tax on transactions.
- The current fiscal situation justifies this option.
Freeing GST rate from the “revenue neutral” concept:
- We need to separate the standard goods and services tax (GST) rate from the bogey concept of a revenue neutral rate.
- The standard rate needs to come down to 15% (as proposed by Arvind Subramanian committee), if not 12% (as proposed by the Kelkar committee).
- A GST reduction would offer a bigger overall benefit for any fiscal shortfall than a cut in individual income tax, which is paid by only about 3% of the population.
- Lower GST should be accompanied by a broadening of the base, and shifting more items from the merit rate to the standard rate.
- The formula for compensation given to the states for their GST collection shortfalls can be reworked, since they too must share some fiscal pain.
Non-fiscal measures to complement the fiscal ones:
- There are a slew of non-fiscal measures too that can help stimulate the economy, such as:
- Reducing the amounts stuck in tax litigation
- Eliminating the “inspector raj”, especially for smaller enterprises that need freedom from tax inspectors
- Reducing India’s still large non-merit subsidies
- Allowing special economic zone players to access domestic markets
- The list of fiscal and non-fiscal measures may look long, but the case for an immediate fiscal boost is forceful.
GS Paper III: Economy