The Economic Survey devoted an entire chapter to make a case for debt-led growth through public spending. They argued that public spending would result in increased incomes by way of a fiscal multiplier and further on, a crowd in private investment as opposed to the classical belief of crowding out. The implication is government spending would raise the demand which has been significantly hit and further raise consumption thus encouraging private investment.
In short, it argues that increasing public spending would not be counterproductive and would keep the public debt in check subject to Interest rate-Growth rate differential (IRGD), which it argues is favourable for India at the moment, simulations undertaken till 2030 highlighted that given India’s growth potential, debt sustainability is unlikely to be a problem even in the worst scenarios.”. In what it terms as breaking asymmetric bias against the fiscal policy, it relies on the IRGD methodology to substantiate the argument.
Simply, it is the difference between the rate of interest on general government debt and the rate of growth (can be either in nominal or real terms). The more negative the differential, the easier it is for the government to ensure the sustainability of public debt. The survey argues that for over two decades the growth rates have been always higher than the rate of interest indicating that India was well placed for raising public expenditure without bothering too much about public debt. Quoting noted economist and President of American Economic Association, Olivier Blanchard , If the interest rate paid by the government is less than the growth rate, then the intertemporal budget constraint facing the government no longer binds, it undertakes a detailed study comparing countries and variables to show that the government should not be shy of rising public debt. Citing data, it shows that the growth variations have been more than in interest adding to the argument that growth has been higher.
What we arrive at, is that for debt to be sustainable, IRGD has to be negative and for IRGD to be favourable, the growth rates have to be high enough. Cross country evidence quoted shows that very few countries have a high negative average IRGD (computed as the average of (r-g) over years) and they were China, India, Russia and Singapore. Based on this, the survey goes on to explore how evidence in India shows that growth leads to debt sustainability and not the other way round. Most would wonder about the causation as to whether higher debt causes growth or not and the survey puts the argument the other way around and observes that there is a negative correlation between growth and debt implying higher growth leading to lower debt (fall in Debt-GDP ratio).
Despite a major cry about fiscal profligacy in India, what we find is India’s total debt is considerably low when compared with other major economies. When it comes to exploring if it’s sustainable enough, the logic used is the primary deficit has to be less than the maximum threshold. Primary Deficit indicates the borrowing requirements of the government excluding interest payment- budget 2021 has set a target 3.1 percent of GDP.
Using policy simulations for 10 years it projects that even in future IRGD would continue to be negative and this follows that the debt that is generated would be sustainable enough. What backs this argument is the fact that External Debt as a proportion of the GDP is currently in safe territory while the general government debt is high.
The survey opines the government go in for an expansionary fiscal policy and to quote the same, it is a call to break the intellectual anchoring that has created an asymmetric bias against the fiscal policy. Once growth picks up in a sustainable manner, it will be the time for fiscal consolidation. But, for now, fiscal policy will have to remain centre-stage to support growth in the foreseeable future.”
In light of the above, the budget presented saw a definitive increase in allocations for major schemes and capital expenditure has gone up to Rs. 5.54 Lakh Crore which is a major increase over the last couple of years. This is a welcome change and a major fiscal push in health expenditure owing to the COVID pandemic which is an inescapable necessity at the moment and only time will tell whether this not only ramps up the facilities at the local level.
A lot of additional spending appears to have been done before the budget as a response to the pandemic by way of Atma Nirbhar Stimulus which raised the estimate of fiscal deficit of FY 2020-21 to a whopping 9.5 % of GDP ( Budget Estimate was 3.5 %) and this well breached the targets fixed by FRBM Act, 2003. This year, despite the Economic Survey asking the government to lead the way by going for a Counter-Cyclical Fiscal Policy and consequently boost confidence among the private players and let them shed risk aversion, the overall Budget expenditure has dropped to 15.6 % of GDP from 17.7 %, pushing the government to go for a less risky fiscal deficit target for FY 2021-22 which is 6.8%. The fear has remained so thanks to poor revenue management wherein a third of the revenues are generated by borrowings and goes into payment of annual interest!
The question that one needs to ask is whether this year’s outlay is enough to raise the rate of growth, bring back animal spirits, boost confidence in the small and businesses that drive India’s growth, and put India back on track while ensuring that the ballooning general government debt does not result into a debt trap and continues to remain sustainable to prove the Chief Economic Advisor right!