RBI’s surplus: To spend or not to spend
- In an unexpected turn of events, the RBI announced last month that it is transferring a sizable dividend to the government, significantly more than what was anticipated.
- This has triggered much discussion about how the government can spend this windfall.
Government Spending
- Fiscal management should be guided by two general principles.
- First, deficits should be kept at prudent levels.
- In India, that level should ideally be around three per cent of GDP for the Centre according to the long-standing Fiscal Responsibility and Budget Management (FRBM) Act.
- Second, governments should spend a bit more than this norm when the economy is doing badly and a bit less when the economy is doing well.
- The purpose of varying the deficit, as specified by the second principle, is to stabilise the economy.
- In bad times, when private sector demand is falling, the government needs to step in and boost demand to prop up the economy.
- The needs are reversed when the economy starts to recover.
- As private demand revives, the government needs to curtail its spending lest overall demand races ahead of supply, fostering inflation.
Inability to curtail Deficit
- Larger-than-normal deficits need to be followed by smaller-than-normal deficits so that government debt gets stabilised instead of spiralling upwards.
- Following these two principles can keep a country out of debt problems while stabilising the ups and downs of growth cycles.
- In India, however, governments have always struggled to spend within their means, irrespective of whether the economy is slowing or booming.
- In the 20-year period from 2000-01 to 2019-20, the average fiscal deficit of the Centre was 4.6 percent of GDP, much higher than the three per cent medium-term target set by the FRBM Act.
- During the pandemic, the deficit shot up to 9.2 per cent of GDP in 2020-21, a large increase but a reasonable one, considering the size of the shock to the economy.
- But curiously even after the economy recovered, the deficit has been slow to come down.
- In the Interim Budget presented earlier this year, the Finance Minister announced that the government was targeting a deficit of 5.1 per cent for 2024-25.
- Three years after the pandemic ended, the deficit is still higher than the pre-pandemic levels, and nowhere close to the FRBM norm.
- The consolidated central and state government deficit is now around 8.5-9 per cent of GDP (compared to the six per cent recommended by the FRBM Act).
Suggestive Measures
- According to some commentators, the government should increase its capital expenditure (capex).
- As per the Interim Budget, the capex growth rate is supposed to slow down in 2024-25.
- But now with this surplus dividend, the government may be tempted to step up its capex spending. That would be a mistake.
- China, for example as part of their infrastructure building spree, built two to three airports in the same city and are now struggling to repay the debt that was incurred for these projects.
- Governments spend on capex for two reasons: To stimulate growth and to meet the needs of the economy.
- Infrastructure in India is definitely a problem that needs to be solved. But not all at once.
- Since the pandemic, the government’s capex spending has been growing at an average annual rate of 30 per cent.
- Not all capex is essential for growth. For example, using Rs 1.6 lakh crore to revitalise telecom MTNL and BSNL is surely not critical, especially when affordable cellphone services are being provided throughout the country by private operators.
- Likewise, it is not obvious that spending lakhs of crores on bullet trains can be justified in a country whose per capita income is less than $2,500.