The Global ANALYST: Fiscal and Monetary Policies

The Global ANALYST, March 2017

Perspective

Economy

Convergence of fiscal and monetary policies needed*

M G Warrier

Though for the outside world and media the differences of views between GOI and RBI provide entertainment stuff, all along, the two (GOI and RBI) have saved the marriage between fiscal and monetary policies by appropriate ‘give and take’ and an unwritten understanding that ‘divorce’ is not an option.

During the fortnight ended February 10, 2017, three documents which should give a fair idea to the common man about the Government of India’s (GOI)approach to the management of the country’s resources during the coming year (2017-18) and the Reserve Bank of India’s(RBI) perception of the health of India’s financial sector, post-demonetization, were released. These are The Economic Survey 2016-17, Union Budget 2017-18 and the Monetary Policy Statement released by RBI on February 8, 2017.

Economic Survey 2016-17

Traditionally, in India, Economic Survey is a document taking stock of the impact of government’s policies and budgetary interventions on the growth profile of the economy and GOI’s perceptions about  the future growth trajectory, presented just before the presentation of central budget which serves as a guide for deliberations on the budget inside and outside parliament. Recent years have seen a healthy change in the drafting of Economic Survey with an untold agenda to use it as a tool for driving in new ideas, which are at a nascent stage, but if successfully ‘marketed’ can bring about faster changes in the economy and social sector. This effort spearheaded by the Chief Economic Advisor Arvind Subramanian is more evident in the Economic Survey 2016-17 which has adopted a ‘thematic’ approach to issues covered by the Survey. We will touch upon two aspects here which can have a long term impact on the financial health of the country and the implementation of social sector schemes in the country. These relate to impact of demonetization on RBI’s balance sheet and introduction of the concept of Universal Basic Income(UBI).

Demonetization bonanza?

The Economic Survey 2016-17 observes:

“Meanwhile, some amount of unreturned high denomination notes. The December 30, 2016 Ordinance has declared the unreturned notes as no longer constituting legal tender. When the grace period expires, the RBI could declare that these unreturned notes are no longer valid

in any way, either as legal tender or as assets that can be exchanged for new currency. When this occurs, the associated liability will be extinguished, and the RBI’s net worth will increase. In this sense, demonetization  has effected a transfer of wealth from holders of illicit black money to the public sector, which can then be redeployed in various productive ways – to retire government debt, recapitalize banks, or even redistribute back to the private sector.”

The idea cannot be faulted on theory.  But the flip side is, the arguments are built up in isolation and by drawing comparisons with small and big nations elsewhere whose stage of development, pattern of governance, role expectations from central banks and relationship between central bank and the exchequer are no way comparable with the role expectations from RBI. For instance the Reserve Balances with Federal Reserve System as on February 8, 2017 was over $2.2 trillion(public debt about $14 trillion). RBI’s share capital and reserves worked out to about  $35 billion(India’s public debt $850 billion). Moreover, as recently observed by former RBI Governor Dr Y V Reddy, the interdependence of monetary and fiscal policies in the Indian context makes reading of RBI Balance Sheet in isolation meaningless. Of course, Reddy didn’t tell it so bluntly. He said, government’s finances and RBI’s resources are interrelated.

This is a wider issue and here only some preliminary observations are made, by way of caution  against any hurried action in the context of arguments put forth in the Economic Surveys 2015-16 and 2016-17 for sucking out capital and reserves of RBI for redeployment in sectors normally financed from GOI’s resources. We will dwell on this issue in detail in the coming months.

Universal Basic Income(UBI)

Prefixed by a couple of excellent memorable quotes from Mahatma Gandhi, Chapter 9 of Economic Survey introduces Universal basic Income asunder:

“Wiping every tear from every eye” based on the principles of universality, unconditionality, and agency—the hallmarks of a Universal Basic Income (UBI)—is a conceptually appealing idea. A number of implementation challenges lie ahead, especially the risk that UBI would become an add-on to, rather than a replacement of, current anti-poverty and social programs, which would make it fiscally unaffordable. But given their multiplicity, costs, and questionable effectiveness, and the real opportunities afforded by the rapidly improving “JAM” infrastructure, UBI holds the prospects of improving upon the status quo. This chapter provides some illustrative costs for a UBI (varying between 4 percent and 5 percent of GDP), and outlines a number of ideas to take UBI forward, highlighting the practical difficulties. UBI’s appeal to both ends of the political spectrum makes it an idea whose time has come perhaps not for immediate implementation but at least for serious public deliberation. The Mahatma would have been conflicted by the idea but, on balance, might have endorsed it.”

So far, discussions on such issues were isolated or confined to academia or research efforts.

For India, once the political leadership gets convinced about a realistic UBI, resources will not be a problem. One possibility is, some vested interests will hijack the proposal of UBI to mix it with “unemployment dole”, an unhealthy practice existing in developed countries. While this should be avoided, care should also be taken to ensure that where employment assurance schemes are implemented, the compensations should be realistic.

There are several pockets in India, including many in states like Kerala, where the local population has successfully eliminated poverty and come up with regard to crucial human development indicators. Attribute it to militant trade unionism or the colour of the flags held by parties in power, the credit for this goes to the insistence by workers for a minimum basic wage. 

Hopefully the concept of Universal Basic Minimum Income, as the debate picks up, will result in healthy deliberations on the need for grassroots level improvements in income distribution to ensure sustainable economic growth. A pragmatic approach to the sharing of wealth can reduce several security concerns world over and ensure better living conditions, not only for the deprived class, but for many from the rich and the powerful who feel insecure today. 

It may be recalled that the Seventh Central Pay Commission (CPC) had fixed the minimum wage for central government employees at Rs18,000. 

Viewed in the above context, GOI will have to concede at some stage the demand for some reasonable relativity for wages of the workers in the unorganised sector with the entitlements of workers in the organised sector having comparable responsibilities. Whenever specific issues relating to job security and compensation are raised by unions or external agencies in the context of human development indicators in India showing uncomfortably low levels in comparison with similarly placed developing countries, some sporadic initiatives are taken by Centre or state governments. 

One such initiative is the introduction of the concept of ‘full-benefit fixed-term jobs’ in the labour-intensive garment sector by the Narendra Modi government recently. However, a comprehensive legislation covering all aspects of service in the unorganised sector is not yet thought of. 

Time is opportune to revisit the prices, wages and income policy. If we do not do this, labour migration issues within the country and flight of skills and expertise from India may rise to unmanageable levels giving rise to several social problems. The revamp of prices, wages and income policy need to be done quickly and for making the processes transparent and findings and subsequent action plans acceptable for the stakeholders, there should be meaningful debates in legislatures and with users of services of workers. 

Strikes like the one on 2 September 2016 should be seen as symptoms of growing labour unrest should be an ‘eye opener’ for initiating corrective action. Protests like this should not be evaluated based on success and failure or losses and gains. Simmering discontent in the workforce emanating from the feeling that there is exploitation by the users of services, taking advantage of the helplessness of the workers, affect productivity and can have long term negative impact on economic growth. Sooner the governments and corporates amend the present approach, the better for the country. Mentioned this to draw attention to the need for ensuring distributive justice in compensations which by itself will reduce the need for subventions of several categories to meet social security needs.

Monetary policy stance

The Monetary Policy Statement presented  by  RBI Governor  Urjit Patel on February 8, 2017 made the following statement:

“The large overhang of liquidity consequent upon demonetization weighed on money  markets in December, but from mid-January rebalancing has been underway with expansion of currency in circulation and new bank notes being injected into the system at an accelerated pace. Throughout this period, the Reserve Bank’s market operations have been in liquidity absorption mode. With the abolition of the incremental cash reserve ratio from December 10, liquidity management operations have consisted of variable rate reverse repos under the LAF of tenors ranging from overnight to 91 days and auctions of cash management bills under the market stabilisation scheme (MSS) of tenors ranging from 14 to 63 days. The average daily

net absorption under the LAF was 1.6 trillion in December, 2.0 trillion in January and 3.7 trillion in February (upto February7) while under the MSS, it was 3.8 trillion, 5.0 trillion and 2.9 trillion, respectively. Money market rates remained aligned with the policy repo rate albeit with a soft bias, with the weighted average call money rate (WACR) averaging 18 basis points below the policy rate during December and January”.

Analyses and articles appearing in the mainstream media these days, in a routine manner, gives an impression that central bank’s monetary policy hovers around upward or downward revision of base rates alone. It is common knowledge now that post- November 8, 2016, there has been deposit growth in banks to the extent that banks were finding it difficult to deploy their resources in remunerative avenues. Mentioned this because, this time around, any change in RBI’s base rates would  not have had much impact on the pool of resources of banks and therefore, one need not be concerned too much about the central bank having left the base rates untouched for the present.

Fiscal Responsibility and Budget Management (FRBM)

The N K Singh Committee which reviewed Fiscal Responsibility and Budget Management (FRBM) Act has submitted its report to the finance ministry. The highlights of the committee’s recommendations reported in the media include:

·        Space for government to spend more on development (translated into common man’s language, this would mean rise in government borrowings),

·        A slightly higher fiscal deficit target (perhaps a band of 3 to 3,5 per cent of GDP in place of the present target of 3 per cent of GDP for FY18 (Keeping in view the leeway to spend more in 2017-18, Chief Economic Advisor is reported to have expressed his dissent on a rigid target)

·        Panel members were of the view that the report should be made public only after Budget 2017-18

Differences of views among  various stakeholders notwithstanding, the arithmetic of Budget 2017-18 will get impacted by the four-volume report now with the finance ministry.

The Budget Speech takes note of the N K Singh Committee report and observes asunder:

“The FRBM Review Committee has given its report recently.  The Committee has done an elaborate exercise and has recommended that a sustainable debt path must be the principal macro-economic anchor of our fiscal policy.  The Committee has favoured Debt to GDP of 60% for the General Government by 2023, consisting of 40% for Central Government and 20% for State Governments.  Within this framework, the Committee has derived and recommended 3% fiscal deficit for the next three years.  The Committee has also provided for ‘Escape Clauses’, for deviations upto 0.5% of GDP, from the stipulated fiscal deficit target.  Among the triggers for taking recourse to these Escape Clauses, the Committee has included “far-reaching structural reforms in the economy with unanticipated fiscal implications” as one of the factors.  Although there is a strong case now to invoke this Escape Clause, I am refraining from doing so.  The Report of the Committee will be carefully examined and appropriate decisions taken in due course.” 

Conflict between fiscal and monetary policies?

Reserve Bank of India Governor Urjit Patel who is a member of the Review Panel, speaking at the Vibrant Gujarat Summit on January 11, 2017, made the following observations:

 “***   *** while some government guarantees and limited subventions can help, steep interest rate subventions and large credit guarantees also impede optimal allocation of financial resources and increases moral hazard. The mandates for these have to be narrow, and thus perforce be deployed judiciously, within a regulatory framework, which RBI has suggested. Guarantees increase government’s contingent liabilities, and add to risk premia for its own borrowing. Guarantees per se at the end of the day have limited utility in solving important sector issues. For example, for small scale enterprises, perhaps non- pecuniary and transaction costs related to clearances, inspections and the taxation bureaucracy are more important *** *** our general government deficit (that is borrowing by the centre and states combined) is, according to IMF data, amongst the highest in the group of G-20 countries. In conjunction, the level of our general government debt as a ratio to GDP is cited by some as coming in the way of a credit rating upgrade. We have to take cognisance of these comparisons and facts as we go forward to make progress. Specifically, this will help us to better manage risks for ourselves, and thereby mitigate financial volatility. In the context of an already adverse external environment that I mentioned earlier, this assumes more importance.

Borrowing even more and pre-empting resources from future generations by governments cannot be a short cut to long-lasting

higher growth. Instead, structural reforms and reorienting government expenditure towards public infrastructure are key for durable gains on the Indian growth front. ”

These observations of  Urjit Patel coming at this juncture gains significance because a supportive fiscal policy is imperative for RBI in chasing the now ‘mandatory’ Inflation Target of 4 per cent (plus or minus 2 per cent with certain pre-decided milestones).

Though for the outside world and media the differences of views between GOI and RBI provide entertainment stuff, all along, the two (GOI and RBI) have saved the marriage between fiscal and monetary policies by appropriate ‘give and take’ and an unwritten understanding that ‘divorce’ is not an option.

Government borrowings and interest rates

US has a per capita public debt of $65,000(Total outstanding debt touching $20 trillion!) . But that country gets government bonds subscribed not just by ‘public’, but by outside world also. In India, public debt really gets subscribed by public, using the captive catchment area of SLR and funds of public sector organisations like LIC. Thus, till such time government securities really become market-friendly, whatever be the arguments in favour of increased borrowing, GOI will have to exercise caution. For the reasons stated here, as the funds mobilized by banks and financial institutions are dictated by market forces, GOI does not have much maneuverability on costs of borrowings.

Challenging job for CEA and RBI

The Economic Survey and the Budget 2017-18 presented on February 1, 2017 reveals that it is going to be a tight rope walk for GOI and RBI to balance the fiscal and monetary policy compulsions from getting exposed to the influence of distrust which is slowly building up in the minds of savers of funds and users of  resources for various political and policy reasons in recent months. India’s economic growth will not depend on the prophecies of economists and analysts, but on how Urjit Patel and Arun Jaitley handle the conflicting interests of monetary and fiscal policies during the coming weeks.

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*Submitted version