RBI’s Surplus: To Spend or Not to Spend

Why in News?

• With a new government at the Centre, the economic policy discourse has now shifted to speculating about the Union Budget for 2024-25 and this year’s budget is especially important for one specific reason.
• In an unexpected turn of events, the RBI announced last month that it is transferring a sizeable dividend to the government, significantly more than what was anticipated.
• This has triggered much discussion about how the government can spend this windfall and there is a need to explore more fundamental question whether the government should spend it at all.

Fiscal Management Principles and Their Purpose

• Fiscal Management Principles
  • 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 normwhen the economy is doing badly and a bit less when the economy is doing well.
• Purpose: Stabilising the Economy through Deficit Variation
  • 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 and as private demand revives, the government needs to curtail its spending lest overall demand races ahead of supply, fostering inflation.
  • A critical aspect of this second principle is that policies must be symmetric.
  • Larger-than-normal deficits need to be followed by smaller-than-normal deficits so that government debt gets stabilised instead of spiralling upwards.

An Analysis of India’s Struggle with Fiscal Management

• Historical Context of Fiscal Deficit
  • From 2000-01 to 2019-20, India’s average fiscal deficit stood at 4.6% of GDP.
  • This figure starkly contrasts with the 3% target set by the Fiscal Responsibility and Budget Management (FRBM) Act, a legislative framework aimed at ensuring fiscal prudence.
  • The FRBM Act was introduced in 2003 with the goal of reducing India's fiscal deficit and ensuring long-term macroeconomic stability.
  • Despite this, successive governments have struggled to adhere to the 3% norm, often citing various economic challenges and development needs.
• Structural Issues and Economic Pressures
  • Several structural issues and economic pressures have contributed to India's struggle with fiscal discipline.
  • These include a growing population, significant developmental needs, and political pressures to increase spending on social welfare programs.
  • Additionally, India's tax base remains relatively narrow, with challenges in tax collection efficiency and compliance.
  • These factors have often led governments to resort to borrowing, thereby increasing the fiscal deficit.
• Pandemic-Induced Fiscal Challenges
  • The COVID-19 pandemic further exacerbated India’s fiscal challenges.
  • The economic shock induced by the pandemic necessitated substantial government intervention to support businesses and individuals. In response, the fiscal deficit ballooned to 9.2% of GDP in 2020-21.
  • This surge was a necessary response to the unprecedented crisis, aimed at providing a safety net for the economy.
  • However, the subsequent recovery phase has seen a slower-than-expected reduction in the deficit.
• Post-Pandemic Fiscal Policies
  • Post-pandemic, the government's efforts to bring down the deficit have been sluggish.
  • The Interim Budget for 2024-25 set a deficit target of 5.1%, which remains significantly higher than pre-pandemic levels and the FRBM target.
  • This slow adjustment reflects the complexities of balancing economic recovery with fiscal prudence.
  • Persistent high deficits indicate underlying issues in fiscal management and the difficulty in reining in spending after periods of high expenditure.

RBI’s Unexpected Dividend and Debate on Increasing Capital Expenditure

• The RBI announced last month that it will transfer Rs 2.11 lakh crore to the central government as dividend, double the amount that had been budgeted.
• The crucial question now is that what the government should do with this unexpected bounty.
• 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 That would be a mistake.

The General Sentiment on Capex, Purpose of Capex Spending, and the Assessment of the Necessity of Capex

• The Sentiment on Capex
  • The general sentiment in India seems to be that any spending on capex is great news which is not correct.
  • 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.
  • What is therefore needed in India is to calculate how much capex is truly needed and of what kind.
• The Purpose of Capex Spending
  • 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.
  • It is not obvious that this pace needs to be increased, or even sustained. On the contrary, recent developments demonstrate that the speed of construction and focus on new projects, rather than maintenance has serious downsides.
• Assessing the Necessity of Capex
  • In addition, 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.
  • It is not critical especially when affordable cell phone 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.

Way Forward: Analysing the Need for Economic Stimulation

• The government must analyse the need to stimulate an economy that is doing so well.
• Given the strong economic performance, it should instead use the surplus dividend from the RBI to bring the fiscal deficit down closer to three per cent.
• There is, however, a caveat to this discussion and this relates to the true state of the Indian economy.
• If the economy is weaker than what the 7-8 per cent growth figures suggest, only then there may be a case for the government to keep spending to support the economy.

Conclusion

• India’s struggle with fiscal discipline is a complex issue rooted in structural challenges and exacerbated by economic shocks such as the COVID-19 pandemic.
• While the government has made efforts to manage the fiscal deficit, sustained high deficits and rising debt levels highlight the need for deeper structural reforms and a stronger commitment to fiscal prudence.

Achieving this balance is crucial for ensuring long-term economic stability and growth.

Q) What is Fiscal Management?

Fiscal Management refers to the process of planning, directing, monitoring, organising, and controlling the monetary resources of an organisation. It involves budgeting, financial reporting, managing cash flows, and ensuring the efficient use of financial resources to achieve organisational objectives.

Q) Why is Fiscal Management important for an organisation?

Fiscal Management is crucial for an organisation because it ensures that financial resources are used efficiently and effectively. Good fiscal management helps in maintaining financial stability, achieving strategic goals, complying with legal and regulatory requirements, and making informed decisions based on accurate financial data.

Source:The Indian Express