The third-quarter data on India’s GDP shows that it has emerged from recession. The data shows a substantial increase in consumer spending by nearly 18 per cent, as compared to the previous quarter. This shows positive consumer sentiment. GDP growth has turned positive and there are signs of continued upward momentum during the fourth quarter as well.
As we look at the next year, there is understandable optimism about a sharp V-shaped recovery and growth of nearly 11 per cent. But much of the high growth next year would be a matter of the economy simply recovering ground lost during the pandemic year. As a result, after two years, the economic size of India would be barely 2 or 3 per cent above what it was in 2019. The presentation of the Union Budget proposals in February have contributed greatly to reviving both consumer optimism as well as business confidence.
Record farm output
The high growth expected will depend quite a bit on the lead to be taken by the private sector, in strong consumer spending, as well in industrial investment. The ratio of investment to GDP has to rise from the current 28 per cent to nearly 36 per cent for the economy to show a sustained growth rate of 8 per cent. Fortunately, agriculture production is at a record level of 303 million tonnes this year. This is almost 10 per cent more than the average for the previous five years.
Some resolution to the impasse in the negotiations between the Central government and farmers agitating against the new farm laws for more than four months now, will go a long way in reviving growth optimism. It will also address the shortages that have arisen due to the blockade, and disruption in the delivery of crucial inputs like coal, fertiliser and even transportation fuel to Punjab and adjoining states.
One of the main reasons for the growth optimism of next year comes from the fiscally expansionary stance adopted by the finance minister. Even though the overall spending is budgeted to go up only by 1 per cent, the expenditure on infrastructure will go up by nearly 25 per cent. And the expenditure on healthcare, including vaccinations and sanitation is up by nearly hundred per cent.
Two noteworthy features of the Union Budget were, firstly the transparency in disclosing all liabilities, and secondly, admitting a very large fiscal deficit. This large fiscal deficit of 6.8 per cent for next year, is not only far in excess of what was specified by India’s own fiscal responsibility law, but also cocks a snook at international rating agencies. There is an irreverent disdain towards the fear of a rating downgrade. A full chapter in the economic survey explains how international rating agencies have always been unfair to India despite the country’s track record of zero default and currently, a high stock of foreign exchange.
Financing the deficit
But this high-risk deficit, while bold and ambitious, should not make us complacent about the challenge of financing it. The gross borrowing requirement by the Centre alone is more than Rs 12 trillion, which is Rs 1 trillion every month. That is just about equal to the monthly GST collection. The total borrowing requirement will eat up the entire incremental deposit in the banking system, assuming an eight per cent growth next year.
If the private sector capacity expansion and investment requires another 12 trillion rupees, it will put pressure on interest rates, since there is not enough funding available to accommodate this huge borrowing requirement. Actually, if the borrowing requirements of state governments is factored in, as well as those of public-sector enterprises, that number is above 23 trillion rupees. This huge borrowing simply cannot be met by the available pool of household savings in the country.
It is here that the Reserve Bank of India has to step in. Of course, it cannot simply print money, because that would be tantamount to monetization, which is explicitly prohibited by a 1997 agreement between the RBI and the Centre. Besides direct monetisation could be inflationary. The RBI can do an indirect monetisation, by buying all the bonds issued by the Government of India in the secondary market.
Indeed, it has been doing so for the last two years. When it buys the bonds against money that it has created, the RBI’s balance sheet expands. That balance sheet has grown by 50 per cent in the past 2 years. And it will grow even further. But a huge volume of borrowing through the market process, i.e. sale of bonds, can put upward pressure on interest rates, as well as crowd out private investments, which too are seeking to borrow from the same banking system and from capital markets.
Bilateral sweetheart deal
One way to ease this pressure, is for the RBI to do a direct deal with the Centre, and give a fixed term five-year loan at a low interest rate against a pledged asset. That pledged asset could be all the shares that the Government of India owns in public sector enterprises. The combined value of all the shares owned by GoI today is more than Rs 20 trillion, thanks to the exuberant stock market. Such a bilateral sweetheart deal is technically not monetisation, outlawed by the 1997 agreement, nor does it disrupt the credit markets, and hopefully takes off the pressure on interest rates too.
Another source of financing for the government of India is, of course, foreign funds. Thankfully, the inflow into the rupee-denominated government debt market has been quite strong and is expected to remain so next year. The government may also consider floating an international dollar denominated semi-sovereign bond through a proxy, such as the State Bank of India. This too can garner funds equivalent to Rs1 or 2 trillion.
It is obvious that none of the required financing can depend on increasing the level of taxation at a time when the economy is coming out of recession. Thus, next year is going to be a difficult balancing task for the RBI. On the one hand, to ensure adequate financing for the government, and on the other, to not let inflation or interest rates get out of hand, while also keeping the currency stable. Not an enviable job at all!
The writer is an economist and Senior Fellow, Takshashila Institution
The Billion Press