Government debt went up less and came down faster than major systemic economies whose imprudence is creating risks for the rest of the world. India has among the best prospects for fiscal consolidation. It is the strategy underlying this outperformance that needs to be understood and emulated elsewhere.
Fiscal stimulus and support during the pandemic was limited and well-targeted. The sharp rise in debt and deficit ratios was more because of the negative (-6.6%) output growth that year. But unlike after the global financial crisis (GFC), when the ratios were allowed to plateau at higher levels, consolidation resumed the very next year (2021-22) as growth recovered sharply and absolute levels of deficits were also reduced. Maintaining stimulus too long after GFC led to over-tightening and low growth in the 2010s.
Higher growth was sustained because of a better composition of government expenditure, reforms that enabled wider participation in growth and excellent monetary monetary-fiscal coordination that kept growth high and inflation within the tolerance band despite shocks. This trio were the components of a successful inclusive growth-enabled fiscal consolidation.
Physical and human capital: Despite limited room since about 40% of central revenue receipts go in interest payments, government expenditure was shifted towards infrastructure investment and creating assets for the poor. Infra investment has the highest output multipliers and spillovers to the private sector. ‘Antyodaya’ – rise of the last person – can be sustained only through empowerment with assets. A Multidimensional Poverty Index shows an additional 135 million people had adequate access to sanitation, nutrition, cooking fuel, financial inclusion, drinking water and electricity in 2019-21 over 2015-16.
The poor are more dependent on public goods and infrastructure since the rich can pay for substitutes. Better private and public assets increase agency of the less well-off and the market size for inducing inclusive market-led innovations, which are a characteristic of the digital age. India’s youthful demography and technology trends multiply such innovation. As more participate in growth, it broadens, deepens and sustains, reducing debt and deficit ratios.Since debt levels are high, successful consolidation requires primary deficits to fall in good times, along with high growth, thus creating buffers for countercyclical spending. Continuing to move towards an ideal of low taxes on a large base is the way to success. The intensive use of data, tax simplification and rationalisation has increased revenue buoyancy and has further to go.Technology enables transfers to those who really need them. Direct transfers do not distort prices and their impersonality reduces leakages and corruption. But transfers do not shift the poor to dynamic higher-income paths. But they need to be repeated, so must be well-targeted.
Fiscal-monetary coordination: Fiscal action is more effective against supply shocks that account for more than half of Indian inflation. A large youthful population and rising retail loans make demand more interest-elastic. Since GoI and RBI can help achieve the other’s objective, coordination can give the best results.
More public investment reduces bottlenecks and chronic cost push. GoI’s long history of intervention in the food economy proved useful under global food price shocks. Countercyclical oil excise tax reduced pass-through of global oil price volatility.
Such fiscal actions enabled monetary policy to keep real interest rates low enough to support growth and reduce risk, yet give savers positive real returns. That nominal policy rates rise with inflation is enough to anchor inflation expectations. Coordination is compatible with central bank independence and credible flexible inflation targeting since accommodation is conditional on inflation.
Real interest rates below growth rates reduce debt ratios. Post-reform India lost this advantage because of high volatility of growth and rates. Post-pandemic countercyclical policy reduced volatility, successfully establishing independence from US policy. This smoothing of external shocks helped keep real interest rates below growth rates and maintain a competitive real exchange rate.
Motivating compliance: Governments have to be committed to consolidation for it to happen, since they can always find escape routes, despite discipline from a large share of interest payments, rating agencies and foreign portfolio outflows for the Centre, and from limits to borrowing and fiscal responsibility legislation for the states. While transparency, with clarity on off-balance-sheet items, has improved in the Centre, it is not uniform in lower tiers.
There is a trend towards competitive pre-election promises of freebies in states – handouts that do not build capacity. These are largely financed by cutting investment, quality of public services, or shifting problems to future governments.
The Election Commission can help voters understand that freebies are never free by asking parties to estimate costs of schemes and also announce what tax will rise or what expenditure be cut to finance poll promises. Arbitrary pricing, such as free electricity, is especially harmful since such measures distort resource allocation. After repeated failures, recent incentive-packages have reduced losses in electricity distribution.
There are attempts to strengthen institutions and incentives to improve state capex, the performance of public utilities, align overlapping state and central rights and responsibilities as well as delegation to the third tier, which is the point of delivery of public services such as health and education. Voter awareness and pressures such as market-determined interest rates would support these essential initiatives to improve quality of state spending.
Finance commissions were mandated to achieve uniform public services through the country, and better compliance may finally deliver this, making growth inclusive and sustainable.