Fiscal reforms are needed to support economic growth: Report

Higher public spending now would make it longer before India returns to the 65% “suitable” ballpark 

India has two key priorities for 2016—preserving hard won macro stability and reviving growth. Macro stability can mean different things at different times.
With the current account deficit comfortably under control, all eyes are turning towards the other indicator of stability, fiscal deficit and public debt, said a recent HSBC report, India’s troublesome twins: How to raise economic growth while lowering government debt.
On the growth front, with private investment largely absent from the scene and prospect for exports unexciting, government spending may need to lend a helping hand. The problem here is that while on good days the twin objectives of higher growth and lower public debt can fall into a virtuous cycle, on a bad day, any one of them derailing can drag down the other.
India’s public debt ratio has risen from 65.5% of gross domestic product (GDP) in financial year (FY) 2013-14 to 67% in FY15 and is likely to rise further in FY16, thanks to falling inflation and lacklustre growth.
Higher public spending now would make it longer before India returns to the 65% “suitable” ballpark. But more importantly, if unexpected macro shocks strike during this period, debt ratios could remain “unsuitable” for the foreseeable future.

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This risk is worth worrying about because macro shocks in the form of lower-than-expected growth, another bout of disinflation and higher interest rates can easily arise in today’s world. In particular, the risk of higher interest rates needs special mention. The 10-year government bond yield has remained stubbornly high over 2015. Among other things, it depends on the demand and supply mismatch in the government bond market, which may get exacerbated in 2016, partly due to pressures from Ujwal DISCOM Assurance Yojana (UDAY) bonds. In short, efforts to support growth by increasing government spending could put pressure on interest rates and exacerbate public debt ratios.
Fiscal reforms needed
So is there a way out for a government that wants to support growth via higher public spending and yet maintain macro stability? There indeed is. If the government is able to undertake a few important fiscal reforms, it can generate enough funds over a short period of time to finance the extra spending.
Food and fertilizer subsidy reforms: Unlike oil subsidy, these have not seen any significant rationalisation. Using the unique identity, Aadhaar platform, in the delivery of these subsidies and moving from product to cash subsidies will not just bring fiscal savings, but also growth gains if the savings are used to finance government investment.
Government stake sales: There are large gains to be had by outlining a clear roadmap for disinvestments and allowing independent market experts to decide on timing. SUUTI (Specified Undertaking of UTI) sales alone can provide 0.35% of GDP worth of funds, and lowering government ownership across other companies can provide a further boost. Over the last few years, there has been a dismal below expected 0.2% of GDP in disinvestment receipts, which can be easily notched up.
Tax revenue improvements: Removing concessional rates and special exemptions from excise and custom duties would not only reduce market distortions, but also add to the tax kitty. Strengthening tax administration by plugging gaps in collection or reporting procedures, strengthening data-warehousing infrastructure, increasing manpower and fast tracking tax disputes are potential reforms.
These reforms alone can provide an extra 0.4% of GDP worth of resources each year for the next few years. Using these savings to nudge up public investment will not only help keep debt levels in check, but also make the economy more resilient in the face of macro shocks. It would provide those extra funds to boost public investment without having an adverse impact on interest rates. And finally it will allow the government to stick to its fiscal consolidation path.
This may be the only way to get onto the virtuous cycle of higher growth and macro stability.
Edited excerpts from HSBC’s report, India’s troublesome twins: How to raise economic growth while lowering government debt.