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Analyzing the IMF's stance on India's fiscal deficit

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With India's growth hitting new lows and monetary policy changes having limited impacts on revival, an option a lot of folks had begun considering was expansion of our fiscal deficit to revive growth. In a recent IMF statement, the IMF seemed to disagree with the option. In today's post we try to understand the reasons behind the stance, look at the alternatives proposed, and see the cases in which this might be the option we have to fall back on.


Macro stability concerns

One thing the NDA government has done right over the last few years is maintained razor-sharp fiscal discipline. Given India's debt levels the IMF considers it prudent that India continues on the path of fiscal discipline that the government has adopted to maintain the macroeconomic stability of the country.


But is the debt that big a number?

India's external debt stood at ~US$550bn as per the last RBI report, almost doubling from the ~US$250bn back in 2010. While the number certainly looks high especially in comparison to historical levels, it is important to remember that India now also has a substantial cushion in terms of ~US450bn of RBI reserves. And while the case for fiscal discipline still stands, the fact that our reserves cover more than 80% of our external debt should be a reason for comfort.


So what is the IMF suggesting and can it be executed in the short/medium term?

One of the options suggested by the IMF was revenue base expansion. This is most definitely an issue on the direct tax front, with tax compliance in the country at extremely low levels. Sustainable solutions to this problem, however, have been hard to come by and while there was a sharp jump in the growth in taxpayers post demonetization with the taxpayer base jumping 13% in the FY16-17 period the number has come down steadily since then. So while this is certainly an area we need to work on in the long run, it isn't likely to provide the required boost in the short to medium term.


Another area India can focus on to revive growth is to make the country more conducive to manufacturing. We already took a step in the right direction on this front with the corporate tax cuts which would make India more tax competitive vs its Southeast Asian peers. We now also need comprehensive labour and land reforms to attract more manufacturing interest. This again is something that sees tremendous execution risk in a country where balancing farmer and tribal rights vs process smoothness on the reform front is easier said than done.


So what options do we have now?

In yesterday's post we looked at the options we had on the monetary front and the innovative ways the RBI was trying to execute new options. But by the looks of it, we certainly seem to be reaching the end of the rope for monetary support. The fact remains that until demand sees a fillip, corporates won't begin hiring and expanding capacity. And as we discussed yesterday, banks seem reluctant to extend cheaper credit to its customers. If Operation Twist doesn't work out as planned, a relaxation of the fiscal deficit target might be the only short term option we have, and despite reservations, in moderation, it wouldn't be all that bad.


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Zapp 5: (Day's 5 top stories in 3 lines or less)

1. Markets remained closed on account of Christmas

2. RBI stressed on the need for banks to resume lending to corporates. Will a few banks still reeling from the impacts of the last corporate debt debacle many banks were falling back on the retail segment

3. The government seems intent to maintain the competitiveness of the Telecom sector. After the 2 year moratorium on spectrum payments, the government is now considering cutting license fee from 8% to 5%

4. KKR and Apax Partners are said to be considering an investment in CCD. Three other players including Oyo are believed to have dropped out of the race.

5. Turkey dug into its refusal to abandon its new Russian missile defense, saying it won’t bow to threat of crippling U.S. sanctions


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