One of the first priorities for the Modi government, now back with an enhanced mandate, should obviously be the economy. The electorate may have been willing to overlook the National Democratic Alliance’s relative economic underperformance in its first term, since there were gains on other fronts (welfare, low inflation, etc.), but in 2024, the economy will probably matter more than anything else. Few voters will believe that 10 years is not enough to deliver achche din.
Fixing the economy needs policies for the short term (fiscal 2019-20) and reforms for the longer term. In the short term, the big question is how to reverse the slowdown visible on many fronts. Reflating the economy, as I argued in my last column, is crucial. The trick is to reflate without stoking the fires of inflation. Can this be done?
The answer is yes. The first priority should be to recapitalize banks without impacting the fisc. If banks need ₹1-1.5 trillion to put their bad loan problems behind them and resume lending, they need this level of recapitalization. The only painless way to do this is to link it to Reserve Bank of India’s (RBI) excess capital. The Bimal Jalan committee has gone into this issue, and if this sum is found to be excess, the money should be entirely, and solely, used to recapitalize banks. Two benefits flow from this: one, it will not impact the fisc negatively, since there is no increase in spending or debts to increase the deficit; and two, it will not impact interest rates. Even if RBI now has less of a capital cushion, a healthy banking system is more in its interest than just capital comfort.
The second priority should be to fix the goods and services tax (GST) pronto. The current rate slabs, which evolved for political reasons and the need to ensure revenue-neutrality in the short run, need to be reduced to three—and only three—rates. These could be 5%, 15% and 25%. This cut in rates will have a huge beneficial impact on demand and production, thus giving both consumption and investment a nudge. The cess to generate extra revenues for compensating states can also be eliminated. We can, however, retain the cess in another form temporarily in the short run. Both the centre and states can be given the right to impose a cess on petroleum products and sin goods (alcohol and cigarettes) if all states agree to let petroleum goods into the GST structure at a 25% rate. To elaborate, there will be two cesses leviable on petro-fuels, one by the centre and another by states, thus allowing both to retain some degree of non-GST revenue flexibility.
In the short term, there will probably be a revenue gap, but this is unlikely to persist in the next financial year. The reflation part comes upfront, since revenue shortfalls will have to be made up with higher borrowings towards the end of 2019-20, but by next year, demand should be roaring ahead, enabling revenues to rise.
A third focus area should be to restore infrastructure spending. The cuts made last year to meet the fiscal deficit target should be restored, and a relaxation of the deficit target for 2019-20 should include a slippage of 0.3-0.5 percentage point, to be recouped in 2020-21. A full return to the glide path can happen over 2021-24, by when the economy should be chugging ahead on three cylinders—public and private investment, and consumption. Exports could remain a question mark due to growing global protectionism, and India’s fundamental lack of competitiveness in many sectors.
Monetary policy clearly needs to kick in. The homoeopathic doses of rate cuts are simply not good enough, and the Monetary Policy Committee must cut rates by 0.5-0.75 percentage point next month. Like the proverbial frog that dies a slow death by failing to jump out when the water it is sitting in is heated too slowly, the economy needs a shock dose of monetary easing so that at least some of the rate cuts are instantly transmitted to borrowers. A 0.75 percentage point cut in the policy rate will see full transmission to borrowers if banks are fully capitalized, and partial transmission if not. A big cut makes more sense now than an overcautious 0.25 percentage point.
Last, it may be a good idea for the next finance minister to present a budget in September or October, maybe by accepting a shift in the financial year to calendar year. It is worth recalling that the National Democratic Alliance presented almost a full budget in February, though it was called an interim budget. There is, thus, no need to rush to present a new one in July, without thinking through all the consequences of the current slowdown. If GST can be fixed, rates cut and spending enhanced over the next three months, and if the monsoon picture is clearer by September, this is the time to shift to a calendar year budget—complete with the new glide path for the fisc from 2020 January.
A shift in the budget year will provide a good reason to let the fisc slide this year, giving the economy a leg-up when it needs it most.
To be sure, a change in the financial year does not make much difference to the proposals to be presented in the Union budget or the Indian economy’s performance in general, but in this changeover year, it would make a lot of sense.
R. Jagannathan is editorial director, ‘Swarajya’ magazine