An Accommodative Fiscal Stance Is Crucial for India

Omicron is a reminder that the COVID-19 pandemic is still not over. This ongoing health crisis should act as a trigger for greater investments in public health in India. Public spending on health by the union government is still below 1 percent of GDP, though the estimate has increased from 0.2 percent of GDP in 2020–21 (revised estimates) to 0.4 percent of GDP in 2021–22 (budget estimates). Strengthening investments in the healthcare sector is crucial at this juncture, as another lockdown can accentuate the current humanitarian crisis and deepen economic disruptions.

In India, the lockdown was announced on March 24, 2020 by invoking the National Disaster Management Act of 2005. As per the Seventh Schedule of the Constitution, healthcare is addressed at the state-level while interstate migration and interstate quarantine are in the Union List (entries 28 and 81), that is, responsibilities of the central government. While the lockdown helped to flatten the curve, an almost irreversible economic disruption resulted in many sectors.

The National Statistics Office released the advance GDP estimates January 7, 2022, revealing that in the financial year 2021–22 (FY 22), India’s GDP growth rate will be 9.2 percent. In FY 21 it was 7.3 percent. However, this growth estimate is lower than that published by Reserve Bank of India (RBI) in December 2021, which was 9.5 percent. The growth in nominal GDP is estimated to be 17.6 percent. These GDP estimates published ahead of the announcement of the FY 23 union budget are significant as they will be used for projections—including those for the fiscal deficit—in the upcoming budget. How India emerges from the pandemic to meet these estimates will depend largely on an accommodative fiscal policy stance when monetary policy has limitations in triggering the growth recovery.

The central bank has done “whatever it takes” when dealing with the pandemic. The RBI has kept policy rates status quo at 4 percent across several Monetary Policy Committee (MPC) decisions. The reverse repo rate was kept unchanged at 3.35 percent to nudge commercial banks toward engaging in credit deployment rather than parking their funds back in at the RBI. The RBI has not yet formally announced any “normalization” procedure, though absorption of excess liquidity was attempted by increasing the cut-off yield rate of variable rate reverse repo (VRRR) to 3.99 percent (as per the four-day VRRR auction held by the RBI on January 6,2022), and curtailing the government securities acquisition programme.

Absorbing the excess liquidity that was injected to stimulate growth as part of the pandemic response  is crucial to reversing trends in nonperforming assets (NPAs). The RBI report on financial stability, published on December 29, 2021, revealed that the macro stress tests for credit risk indicate a possible rise in the gross nonperforming asset (GNPA) ratio of scheduled commercial banks from 6.9 percent in September 2021 to 8.1 percent by September 2022 (baseline scenario). Under a “severe stress” scenario, the macro stress tests for credit risk indicated that it can increase up to 9.5 percent by September 2022.

Against the backdrop of “taper tantrum” and possible interest rate hikes by the US Federal Reserve, there is mounting pressure on the RBI to increase their interest rates to prevent capital flight. Globally, central banks have started increasing the interest rates, however the RBI has not yet made a firm decision to increase the rate, as it could affect growth recovery.

Inflationary pressures are also mounting. In India, the wholesale price index (WPI) inflation rose to a record high of 14.32 percent in November 2021 as per the data released by the Ministry of Commerce and Industry. The consumer price index (CPI) inflation is 4.91 percent, though that is still within the comfort zone of the inflation targeting framework envisaged in India’s new monetary framework, with the nominal inflation anchor at 4 percent (with a band of +/- 2). However, the widening gap between WPI and CPI is a matter of concern, however, it has been argued that the inflation we are currently experiencing is transitory in nature due to supply chain disruptions and volatile energy and food prices.

Given these macroeconomic uncertainties, maintaining an accommodative fiscal policy stance in the upcoming union budget for FY23 is crucial for a sustainable recovery. The fiscal deficit as a percentage of GDP rose to 9.5 percent in 2021–22 (revised estimates). The RBI estimates suggest that revenue deficit preempted about 70 percent of the gross fiscal deficit during the period 2018–19 to 2019–20, and increased further to 79 percent in 2020–21 (revised estimates) and 76 percent in 2021–22 (budget estimates). Any attempt at fiscal consolidation at this juncture employing capital expenditure compression rather than tax buoyancy can adversely affect economic growth. Public investment—infrastructure investment in particular—is a major growth driver through “crowding-in” of private corporate investment. The initiatives made to strengthen capital infrastructure in the last union budget were welcome, though we need to further sort out the ambiguities related to the institutional mechanisms and financing patterns of the national infrastructure pipeline.

Bringing down the fiscal deficit now can be detrimental to economic growth recovery. The plausible “fiscal risks” arising from the mounting public debt and deficits need to be tackled with a medium-term roadmap for fiscal consolidation, as instantaneous deficit reduction can affect the sustainable growth recovery process.

When credit-linked economic stimulus has an uneven impact on growth recovery, the significance of fiscal dominance cannot be undermined. We argue that the upcoming union budget for 2022–23 should maintain an accommodative fiscal stance in order to support the sustainability of economic growth process and also for financing human development, which is crucial in the time of a pandemic. Rising unemployment needs to be addressed through an urgent policy response that strengthens job guarantee programs.  The welfare models of government in providing food security to poor households and designing gender budgeting in energy infrastructure are also welcome. However, we need to go further to strengthen social-sector policies in the time of a pandemic. The widening digital divide is affecting education outcomes of children, and in a recent anthropometric analysis from the National Family Health Survey (NFHS) (5th round, conducted during January 2020–April 2021) data on stunting and wasting among children indicate malnutrition is an emergency in India.

To deal with these issues and more, maintaining an accommodative fiscal policy stance in the upcoming union budget for 2022–23 is crucial.

Chakraborty is a Levy Institute research scholar and professor at India’s National Institute of Public Finance and Policy (NIPFP) and Harikrishnan is an independent analyst.