The 2020 Union Budget will prove to be a tough balancing act for India's Finance Minister Nirmala Sitharaman and her team of experts with some of the most crucial figures – retail inflation, growth, fiscal deficit, employment rate, consumption – looking at the worst performance in years.
Looming stagflation
The spike in retail inflation to 7.35 per cent in December, piercing way past the Reserve Bank of India's 2 to 6 per cent target, will prove as one of the most challenging factors for the architects of Budget 2020.
Inflation, which was only 2 per cent, has been showing a consistent rise since August 2019. Put this in perspective with India's six-and-a-half-year low growth rate of 4.5 per cent in the last quarter and you are staring at the most dreaded trap of modern economy- 'stagflation'.
A 'stagflation' is an undesirable phenomenon which means persistently high inflation with high unemployment and a stagnancy in demand.
Retail inflation or headline inflation is a consumer price index (CPI) based inflation calculated from a basket of 260 commodities including a few services. Besides core commodities, headline inflation includes certain volatile categories such as food and fuel, that is, noise. The presence of noise makes retail inflation more prone to commodity price fluctuations, weather and supply shocks. But the fact that much of the inflation is attributed to noise makes stagflation less likely.
According to a report published by rating agency Crisil, though core has a greater weight, the share of noise in headline inflation has gotten louder, from a miniscule 18.5 per cent in April 2019 to 74.9 per cent in December. Much of this rise is on account of food inflation.
The food inflation, primarily driven by price rise in vegetable and pulses was at 14.2 per cent in December as opposed to (-)2.65 per cent, a year ago.
Though the high inflation is largely driven by a massive increase in vegetable prices, a transitory factor which is likely to pass in near future, the RBI is unlikely to ignore the trend while fixing its monetary policy as controlling inflation is the task of the central bank.
Easing the monetary policy could further drive up prices by stimulating demand. The central bank has already surprised watchers by keeping rates unchanged contrary to expectation of a cut to boost the sagging economic growth. RBI's tight monetary policy willI prove as a challenge to the finance ministry if it is looking at deficit spending as a way out of economic slowdown.
Fiscal deficit
Fiscal deficit, the net borrowing of the government in the first eight months of FY20, stood at 15 per cent above target.
At an aggregate level, expenditure has been in line with the budget trend. However, the corporate tax cut, the average GST collection, the shortfall in excise and customs duties are likely to compromise the aggregate revenue substantially.
The claim by former Economic Affairs Secretary SC Garg on Tuesday that the fiscal deficit is likely to range between 4.5 per cent to 5 per cent as against the target of 3.3 per cent set last year is none too welcoming.
Garg went on to state that last year's fiscal deficit which stood at 3.3 per cent was underestimated by an entire percentage point. It had to be 4.7 per cent, he said after adding expenses outside the Consolidated Fund of India and Public Account to the calculation.
A higher fiscal deficit inevitably implies higher borrowing by the government and higher interest rates.
High unemployment rates
India's unemployment rate which hit 7.7 per cent in the month of December as opposed to 5.49 per cent a year ago, indicates that the country needs to aggressively work towards job generation.
Official data indicates that the country hit a 45-year-high unemployment level in 2017-18.
Depressed consumer demand
The fall in consumer demand after a steady growth for four consecutive decades is yet another issue the government has to tackle with. A glance at the leaked draft of the NSSO data reveals that the average monthly spending by an individual fell to Rs 1,446 in 2017-18 from Rs 1,501 in 2011-12 – a dip by 3.7 per cent.
If the figures in the survey are to be taken at face value, it implies that India -- both urban and rural — is grappling with several consumption related issues such as a severe trade-off between education, health and nutrition; undernourishment; and falling living standards.
Solutions
To address the mutifarous issues, the government has taken several steps since August, including corporate tax cuts, liquidity support to housing finance companies, one-time partial credit guarantee to public sector banks for purchase of high-rated pooled assets of non-banking finance companies (NBFCs) and mega merger of public sector banks.
However, given the deep demand deficit, India will do well to take a leaf out of Keynesian economics, that is, economy will need more demand side corrections as opposed to the aforementioned supply side reforms.
According to Keynes, the volume of employment in a country depends on the level of effective demand of people for goods and service, and boosting effective demand could give economy the much needed upliftment it needs.
A lower tax could increase the purchasing power of the consumer and boost demand.
Though politically motivated to an extent, some of the key issues highlighted during the Bharat Bandh held on January 8 are essentially economic problems.
The various demands raised by the trade unions – increase minimum wages to Rs 21,000, prevent modification of labour laws to benefit businessmen, reduce inflation, strengthen public distribution system, ensure minimum support price for farmers' produce, farm loan waiver, solve unemployment crisis — are intrinsically linked to aggregate demand.
Significant reforms in health and education which eat up a major portion of the average household's income will also prove beneficial to the economy at large.
