Sorry Piyush Goyal, those fiscal deficit and double-digit growth targets are unrealistic

Sorry Piyush Goyal, those fiscal deficit and double-digit growth targets are unrealistic

On Monday, the interim Finance Minister Piyush Goyal, who also leads the Railway ministry, made two important declarations about the government’s performance this fiscal year.

Goyal said that the government would meet its targeted fiscal deficit, which measures the difference between expenditure and revenue, of 3.3% of GDP owing to a reduction in expenditure. He also said that the economy could grow at a rate of at least 10% in the final quarter of the year.

In principle, these targets contradict one another, since government spending is necessary to boost growth. But then, election year is all about such announcements. The purpose behind Goyal’s message was clear. He wants to restore confidence in the economy.

2018 hasn’t been a great year for India so far. Foreign portfolio investors are pulling out their money and exiting the country in droves, the rupee looks to be headed to an all-time low against the dollar, inflation is picking up on the back of a protracted rise in oil prices and the bad loan problem is worsening.

Misplaced confidence

However, the economy did manage to clock a growth rate of 7.7% in the quarter that ended March 2018, making India the world’s fast growing economy. This gave the government the ‘confidence’ it needed. The government cited the growing formalisation of the economy and the pickup in construction and manufacturing as positive signs for the short-term.

But the 7.7% growth was largely a result of the fact that GDP in the Jan-March 2018 period was measured against the corresponding period in 2017 - the quarter that followed the government’s demonetisation announcement where growth fell to 6.1%.

This “feel-good effect” is set to continue. The growth rate for the current April-June quarter will also receive a boost from the fact that it will be measured against the first quarter of fiscal 2018 - the quarter before the implementation of the GST where growth declined to a three-year low of 5.7%.

A number of headwinds remain in the short term, such as increasing interest rates in developed economies, high oil prices and a rising trade deficit. In addition to these factors, the government is most likely to fall short of its financial targets for other reasons.

More spending and less revenue

In his Union Budget for 2018-19, Arun Jaitley revised the government’s fiscal deficit target for the previous year to 3.5% of GDP from 3.2%. A revision is likely due for next year’s budget as well. Barring the fact that the government’s paying a lot more for oil than its accustomed to, it will also have to contend with a number of spending obligations ahead of the national elections in mid-2019.

It will continue to pump funds into India’s state-owned banks as the write-offs for bad loans touch record levels. At the same time, the government will have to ensure spending on public welfare and subsidy schemes to keep rural voters happy.

And what will finance this spending?

The government is targeting around ₹800 billion worth of revenue from its disinvestment programme. However, that looks to be in serious disarray given the failed attempt at offloading a 76% stake in Air India. The Department of Investment and Public Asset Management is reportedly planning to sell a stake in Coal India to offset this.

Sluggish investment and credit demand

A recent hike in interest rates by the Reserve Bank of India - the first in four years - will lower demand, not only for corporate loans, but also home and car loans.

A slowdown in corporate credit, which is already a supply issue given the battered balance sheets of banks, will hurt capital investment and exports - the two necessary drivers of growth. The fall in private consumption won’t help either.

The economy can’t rely on public expenditure alone, especially given the government’s deficit targets. Any further rate hikes this year, which are expected if inflation doesn’t fall and the rupee continues to deteriorate, will make things worse.

Double-digit growth seems like a dream for now. As indicated by the implementation of the GST and demonetisation, India simply lacks the ability to implement structural reforms. Furthermore, while jobs are being created, the severe shortage in skills is pushing India’s youth into low-quality work.

At a recent meeting of Niti Aayog’s governing council, Prime Minister Narendra Modi said that India could achieve an economic growth rate of 10% or more by 2022 (a far cry from the plans for 2019) but this would require an increase in development spending.

The steps Modi outlined to achieve this were mostly expenditure-related. They included a greater financial support to farmers, infrastructure development in backward districts the successful implementation of the national health insurance scheme.

Hence, India’s growth ambitions will come at a price, and it might boil down to a trade-off between a fiscal deficit and growth. Election year or not, the government will be keeping a close watch on its spending, even if it means growth in the late-single digits.