FM’s trilemma: Limit fiscal deficit; boost spending, welfare expenditure

  • Gaurav Choudhury, Hindustan Times
  • Updated: Feb 29, 2016 16:05 IST

File photo of Union finance minister Arun Jaitley (Reuters)

For the sake of analysis it is sometimes tempting to divide the world into two broad groups: Those that export basic commodities and those that buy these. In an increasingly integrated world, where goods travel across borders seamlessly, the volume and direction of commodity shipments can prove to be a useful guide to gauge the health of economies.

Any textbook primer would tell us that commodity markets are pretty much governed by the laws of demand and supply. Stronger demand for a product will push up its price and vice versa. In the current context, in addition to the mismatches in demand and supply there is also a speculative component, particularly in two principal commodities — gold and oil — that are shaping the price curve.

Policymakers across the world, more so in middle income countries such as India, which is an engine for global growth, continuously keep one eye on these trends that offer meaningful prescriptions to nurse festering wounds in the local economy.

The fact that each country has a much more complicated net commodity export position makes it nearly impossible to formulate a model one-size-fits-all template for macroeconomic managers to adopt. Divergent commodity price moves can have seemingly contradictory effects on different economies.

For India, indeed for the world, the level of action on the factory floors of China is of far greater consequence given the economy’s size and its influence over global commodity prices. Slow growth in factory output and a deceleration in import shipments of a raft of commodities — iron, copper, tin, nickel, and even oil — to China could potentially keep global commodity prices tempered down.

Regardless of the few signs of healing in the US economy, growth continues to remain weak at a global level. A sputtering West is usually not good news for China, the world’s factory and official numbers reinforce this point. China is falling off a cliff snowed under a mountain of problems. The US and the European nations are still wobbling and trying to reach a steady state.

For India, while the persistent drop in commodity prices has offered a fiscal cushion, the unrelenting slump in merchandise shipments to the rest of world could be emblematic of a deeper problem. This is showing up in a few metrics that seemed to have escaped attention in the current mainstream narrative.

Let us examine a few markers: Brokerage and research houses have downgraded the average earnings per share (EPS) estimates of some of India’s top companies by about 21%. EPS, the portion of a company’s profit allocated to each outstanding share, is a gauge to measure a company’s profitability. The downgrade in EPS or the expected drop in profitability is the sharpest since 2008 when the stunning collapse of Wall Street icon Lehman Brothers pushed the world economy into its worst crisis in 80 years. The forecast about future profitability is the most pessimistic among banks and commodity companies which have been pummelled by piling bad debt and slumping prices respectively.

It is only natural that such gloomy profitability forecasts about large companies will also show up in the balance sheets of their smaller brethren. Indeed, the smallest traders have been the worst affected as shipment orders dry out. There are about 30 million micro, small and medium enterprises in India. Put together, these factories contribute to half of India’s factory output, 45% of exports and employ more than 60 million people (India’s organised service sector employs about 33 million).

Such a shaky external backdrop makes the task of finance minister Arun Jaitley even more difficult ahead of the presentation of the Budget on February 29.

A few variables stand out as most influential. First, if the first two years of the current government were about proof of concept, the next few years will be about proof of delivery. Having declared its intent through “Make in India”, “Digital India” and “Start-up India” and similar initiatives, the clock is now ticking to come good on the execution of these.

Second, while India has cantered past China as the world’s fastest-growing economy, its ability to stay above the 8% growth curve will critically depend on domestic spending and investment. How do you spot an economic revival without poring through reams of statistics put out by the official number crunchers? Households spending more are early signals of the onset of an economy-wide revival. The clearest indications are available in any market or mall. These, in turn, get reflected in corporate balance sheets and bank loans. The finance minister will be acutely aware that this doesn’t seem to have been the case over the last two years.

Third, the finance minister has little legroom to splurge on extra spending. Tough measures, like cutting subsidies, mean prices going up and away. Raising duties such as service taxes to generate funds welfare programmes, building infrastructure and making banks healthier will pinch family budgets. The resultant high inflation could be bad news for growth. Conversely, cutting taxes to give more money into the hands of people to spend and companies to invest would mean lower earnings for the exchequer. This could force the government to borrow more, shrinking the banks’ pool of resources available for lending to companies and individuals. This, in turn, may prompt banks, already beset by a mount of bad loans, to raise borrowing costs.

Mr Jaitley faces what economists call the classic “trilemma”: Containing the fiscal deficit within manageable limits, boost domestic spending and investment and enhance welfare expenditure. Achieving all three together is well nigh impossible. It may be prudent to bear some short-term pain and decisively shift the policy mix towards achieving two of the three goals rather than maintain the status quo. 




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