Topic 1 : Mint Street musings: On the interim Budget and the RBI
Context: The interim Budget gives the central bank some more room to manoeuvre
Introduction
- The latest bi-monthly meeting of the Reserve Bank of India’s Monetary Policy Committee (MPC), whose outcomes will be revealed by RBI Governor Shaktikanta Das on February 8, is widely expected to result in a status quo on interest rates yet again.
MPC Review Summary
- Five of the six MPC members voted to continue with the "withdrawal of accommodation" stance at its most recent review, which took place in early December.
- The panel also increased its GDP growth prediction for the year from 6.5% to 7%.
- It is unlikely that the position will change to "neutral," but it would be interesting to observe if the growth estimate is re-examined in light of the National Statistical Office's forecast of a 7.3% increase in 2023–2024.
U.S. Federal Reserve and India’s policymakers!
- The U.S. Federal Reserve held interest rates for the fourth straight review last week, and chairman Jerome Powell was vague about the proximity of much-anticipated rate cuts this year, seeking more data to establish that inflation had been reined in sustainably.
- India’s policymakers may not take a direct cue from the U.S. Fed, but the concerns are similar as Governor Das had articulated in December. The 4% inflation target remains elusive for now — December’s inflation rate hit a four-month high of 5.7%.
- The RBI expects inflation to average 5.2% in this quarter, which it only expects it to cool to 4% in the July-September phase, providing a window for a rate cut consideration if the monsoon is normal.
Interim Budget and the RBI
- Finance Minister Nirmala Sitharaman’s interim Budget for 2024-25, however, could give the central bank some more room to ease liquidity constraints in the economy.
- While the government did not provide a prop for weak consumption trends, it is also not adding to inflation pressures.
- A stronger than expected pursuit of fiscal consolidation in this year and the next, and a promise to lower gross market borrowings from ₹15.4 lakh crore this year to a tad over ₹14 lakh crore in 2024-25, should help.
- The Minister asserted that this will free up more credit for the private sector now that industry is beginning to invest ‘at scale’. Gross market borrowings as a share of the fiscal deficit will also drop below 84% from 89% this year.
- With foreign capital inflows into Indian government bonds likely to spike following their inclusion in global bond indices, banks which are the major holders of these securities and are facing elevated credit to deposit ratio growth rates, should get more space to lend. Economists expect this to help lower borrowing costs for the entire economy.
Conclusion
- Yields on government bonds have already dropped from 7.14% ahead of the Budget to about 7.05% and could drop further, even as systemic liquidity has improved a tad. For Mint Street hawks, that is no small comfort.
Topic 2 : The severe erosion of fiscal federalism
Context: Borrowing restrictions in States provide an example of ‘annihilative federalism’
Introduction
- Kerala Chief Minister Pinarayi Vijayan is set to lead a protest in New Delhi against the Centre for imposing a financial embargo on the state, accusing it of pushing the state into a severe financial crisis and violating Article 293 of the Constitution.
What is net borrowing ceiling?
- The NBC limits the borrowings of States from all sources including open market borrowings.
- The Centre has decided to deduct liabilities arising from the public account of the States to arrive at the NBC. In addition, borrowings by state-owned enterprises, where the principal and/or interest are serviced out of the Budget, or through assignment of taxes or cess or any other State revenue, are also deducted from the NBC.
- Kerala is particularly agitated by the inclusion of debt taken by state-owned enterprises as the State’s own debt.
- Major infrastructure projects initiated by the State government are funded by the government statutory body called the Kerala Infrastructure Investment Fund Board (KIIFB), primarily through extra-budgetary borrowings.
- Since the debt of KIIFB is now included in the NBC, the State government claims that it is not even able to fund pensions and meet expenses for welfare schemes. Is the Centre within its constitutional limits to impose such harsh conditions on the finances of States?
Constitutional Considerations on State Debt
- The Constitution mandates that the State must obtain the consent of the Centre to raise any loan, if any part of the previous loan is outstanding. The imposition of the net borrowing ceiling (NBC) is done by invoking the Centre's powers under Article 293(3).
- However, the Centre's decision to include extra-budgetary borrowings by state-owned enterprises in the total debt of the State is constitutionally suspect.
- The Union Finance Minister justified this decision by relying on the 15th Finance Commission Report, which suggests that governments should resist adding off-budget transactions and contingent liabilities to maintain fiscal transparency and sustainability.
- The Finance Commission has not called for the inclusion of state-owned enterprises' debt in the NBC.
- Parliament does not have the power to legislate on the 'Public Debt of the State', so the State Legislature has the power to make laws on, administer, and determine aspects of the public debt.
- The State government argues that the State's public account balances should not be included in the NBC. They argue that the State government can collect money under 'public accounts', such as small savings, security deposits, provident funds, reserve funds, and other treasury deposits, which are within the State Legislature's domain.
- The Centre has no power to include withdrawals from public accounts in the NBC.
State territory.
- The Kerala Fiscal Responsibility Act, 2003, which is enacted by the State Legislature, spells out the fiscal deficit targets for the State.
- It says that Kerala shall reduce the fiscal deficit to 3% of the GSDP by 2025-2026. When a State Act provides for budget management and fiscal discipline, it is not desirable to have external supervision on the finances of the State by the Centre.
- Under Article 202 of the Constitution, it is the State government that is tasked with determining the revenue and receipts and corresponding expenditure and with presenting the Budget of the State before the Legislative Assembly.
- Budget management of the State is the discretion of the State government. The territory occupied by the State executive and legislature cannot be ceded to the Union executive and Parliament in the name of fiscal management.
- Even otherwise, Kerala’s fiscal deficit is reported to have significantly reduced to 2.44% and revenue deficit to 0.88% of the GSDP. In the Centre’s case, the fiscal deficit is estimated to be 5.8% for 2023-2024.
- The KIIFB was a novel idea in Kerala to fund infrastructure and development projects through extra-budgetary spending. But the State’s responsibility to fund development work cannot come in the way of it delivering justice to pensioners and beneficiaries.
- If the Kerala Finance Minister is to be believed, not permitting the State to borrow will affect the State’s spending on welfare schemes. This can lead to a catastrophic situation in the revenue-scarce State.
Conclusion
- The character of India’s federalism is moving rapidly from cooperative to one that is destructive and annihilative. The borrowing restrictions are an example of ‘annihilative federalism’ at play.