FRBM & Political Economy
Fiscal Responsibility and Budget Management (FRBM).
As we are continuously reading/hearing news of high inflation and a potential stagflation world over, FRBM assumes a particular importance in India.
In the backdrop of COVID, government was generous enough to go for fiscal expansion but as they say there is nothing like a free lunch, there are definitely costs that our future self and future generations will have to bear for such govt actions.
FRBM Act was enacted in 2003 to ensure
1. Fiscal discipline in govt’s finances (target of 3%)
2. Intergenerational equity
3. Long term macro-economic stability
Fiscal deficit refers to the shortfall in govt’s revenue over its expenditure. This is the net borrowing requirement of govt.
Concerns with high fiscal deficit:
1. It leads to high borrowing by govt which tend to increase interest rates in the market and thus leads to crowding out of private investment.
2. Creates inflationary pressures in the economy and inflation acts as a tax on poor.
3. It increases the interest burden on the govt which might lead to higher tax on the income of future generations
Benefits of fiscal prudence:
1. Better credit rating leading to positive outlook of the economy and thus facilitating FDI in the country
2. Better sovereign credit ratings, loans would be available at cheaper rates in international market which can play remarkable role in development of social and physical infrastructure.
Now the question comes what could have been during the times of COVID?
During the times of COVID there was an international consensus to infuse Keynesian stimulus so strict adherence FRBM target was neither possible and nor desirable in the economy but what could have been done better?
The spending should have majorly gone for capital expenditure e.g., port building, roads construction etc., as infra development acts as a facilitator and helps in crowding in private investment and there is a multiplier effect in the economy.
Easier said than done. We are a democracy and future generation is not going to vote in next general elections. This gives the birth to the politics of populism to please voters. Freebies are a good politics but terrible economics and this is where the honest taxpayer bear most of the burden.
Macroeconomic uncertainty and rising interest rates.
Fed has increased the fed fund rates multiple times this year and now at 4.25 – 4.5%, the rate is highest in 15 years.
What is fed fund rate?
This is the rate at which one bank lends to another on an overnight basis.
Why fed is increasing rates?
During the start of COVID, fed decided to arrest the potential COVID induced slowdown by printing money.
The money equation says:
Money Supply*Velocity of money = Nominal GDP (Price * Real GDP)
In short term real GDP cannot increase unless we make substantial improvement at the supply side of the economics and expand capacity which is very difficult in the short term. Velocity of money is a behavioral variable which is fairly constant in short term. Now that means money supply has direct bearing on the price levels prevailing in a economy and sustained increase in the price levels in the economy is called inflation.
Central banks world over are following inflation targeting regime where they try to control inflation by monetary tightening i.e., reducing the money supply which is achieved by increasing interest rates.
Has fed been successful so far?
Fed has increased the funds rate seven times this year and the latest increase being 50 bps (last four were 75 bps). Retail inflation although came down to 7.1% from the highs of 9.1% in June but it is still far away from the Fed’s target of 2% which means this is not the end of hawkish stance of federal reserve. It will continue to increase rates and is projected to reach 5.1%.
Now the concerning fact is US unemployment rate is at historical lows which has led to the wage inflation. Increase in rates will discourage firms from expanding and create jobs. We can correlate this with the recent layoffs that have been happening in the tech companies. Please note that number of employees are still higher than pre-COVID phase at these companies.
Higher fed rates and Indian economy – This leads to movement of investor’s money to US to benefit from higher interest rates (hot money). While this will definitely have an impact on stock markets, more severe would be the impact through deteriorating exchange rate and hence increase in imported inflation which RBI might tackle with higher repo rates and hence might take India down the growth trajectory.
Take a listen to the video where I asked the question the then IMF chief economist about a year ago.
Multilateralism & India
Recently, Finance Minister of India Nirmala Sitharaman mentioned about the need of reformed multilateralism and how India with its G-20 presidency has assumed the responsibility of bridging the global north and global south divide.
What is multilateralism?
It is the practice of coordinating national policies based on generalized principles of conduct and diffused reciprocity, in collaboration with multiple countries through an ad-hoc arrangements or by means of institutions.
There is no global government but there is need for global governance as certain problems need global solutions. For e.g., climate change, outer space, global trade, food security and other economic and security challenges.
Current state of multilateral institutions-
Multilateral institutions – as they stand today – can at most boast their achievement of being alive otherwise their inefficacies in dealing with global challenges have invited them questions to their relevance in the changing world order. The existing set-up is coming from the reference of post war unipolar or at the best bipolar world and no longer represent changed geo-political realities as shown by their failure to forge consensus to prevent conflicts e.g., Ukraine-Russia war.
The world today is multipolar with different centres of power, as a result multilateralism in its current form is dying and hence, we see the rise of mini-laterals i.e., the groupings based on shared interest and objectives for e.g., SCO, QUAD, BRICS etc. One big challenge that come out of the presence of such groupings is the “Kindleberger trap” – Inability in the ensuring the provision of global public goods due to the void in global leadership.
There has been a call from “Third world” countries for reformed multilateralism i.e., a system of institutions that reflects the contemporary balance of power and broader representations of developing and emerging economies.
Now the question comes –
How much effort should India put in the addressing the reformation challenge of these institutions given their failure in addressing global issues from time to time?
Also, what if the reformation means the pre-eminence of China in these institutions?
India & multilateralism –
India since its independence has been a strong advocator of multilateralism and has been a major contributor to UN peacekeeping, counter-terrorism, human rights and environmental protection.
Recently, India played a role of pharmacy to the world by supplying essential drugs and vaccines during COVID-19 crisis.
Multilateralism matters to India as its ability to sustain and positively influence multilateral processes will have a direct bearing on India’s emergence as a global power and protect its strategic autonomy.
G-20 presidency gives India a handsome chance to put forward the agenda for global co-operation as world emerges from pandemic. G-20 group’s importance is reflected from its economic clout as member countries accounts for more than 80% of world GDP, 75% of global trade and 60% of global population.
This is an opportunity for India to project itself as an emerging global power.
Economic, geo-political challenges & G-20 presidency –
India has assumed the G-20 presidency in one of the trickiest of the times where there is an anticipated economic recession – worsening un-employment, inflation etc. which make countries turn inwards to address domestic concerns and greatly reduces international co-operation. Moreover, world is increasingly polarized due to Ukraine-Russia conflict and also, we have an emergence of new cold war between US and China.
It would be interesting to see how India walks the tight rope with its theme of “Vasudhaiva Kutumbkum” (“World is one family”) to address global challenges.