Is Budget Facing Impossible Trinity- Asset Swap

The collapse in global commodity prices partic-ularly oil has further reinforced macroeco-nomic stability in India and cemented Indias sta-tus as the model child within the emerging marketuniverse. But, despite this, growth and private invest-ment remain in a funk, afflicted by overly-leveraged pri-vate infrastructure firms, and by risk-averse public sec-tor banks that are weighed down by elevatednon-performing assets and who awaita significant recapitalization from thegovernment the fiscal space forwhich is not apparent.

It is against this backdrop that mar-kets are eagerly awaiting the Budget,hoping that it can simultaneouslyjumpstart growth while reinforcingmacro-economic stability. Doing sowill not be easy, however. In fact, pri-ma facie, the Budget faces three poten-tially conflicting objectives animpossible trinity, so to speak.

First, as the governments mid-year economicanalysis correctly identified, public investment needsto step up to the plate. Non-defense capex spending ofthe central government budget averaged two per centof GDP between 1992 and 2008, but has fallen to just oneper cent of GDP the last five years. Given the woesafflicting private investment, more public investmenton infrastructure is sorely needed to boost productiv-ity and gradually crowd-in private investment.Questions about state capacity will inevitable arise:does the state have the implementation capacity toidentify, contract out and monitor a slew of publicworks projects? But thats where this government willneed to show its mettle.

But, more fundamentally, where will the fiscal spacefor this come from? It is tempting to believe that, in a bid

to boost public investment, the medium-term fiscalpath for the central government deficit 3.6 per cent ofGDP in FY16 and three per cent in FY17 should be tem-porarily abandoned. But that would be a dangerousapproach given the level of Indias deficit and debt.Indias consolidated fiscal deficit is currently close to 6.5per cent of GDP, while countries with the same sover-eign rating as us have a median and mean deficit of 2.5

per cent of GDP 400 bps lower! Theinflation tax has been chipping awayat Indias debt/GDP ratio, but at 65per cent it is substantially higherthan the 40 per cent debt/GDP ratio ofthe median country amongst our sov-ereign ratings peers. Deviating fromthe laid out path of fiscal consolida-tion could raise questions about fiscalcredibility and make ratings agenciesand foreign investors nervous in ayear when the Fed is poised to raiserates and the appetite for emerging

market assets may diminish. What if growth is weakagain next year? Will authorities again abandon a newfiscal road-map? This is a slippery slope and in therules versus discretion debate, the former has clear-ly won out in India over the last decade.

But, as if all this is not enough, the third simulta-neous challenge, is to ensure that even as the fiscalis consolidating it is not generating a negative fis-cal impulse on the economy, and thereby makingfiscal policy pro-cyclical (i.e. tightening the fisc whengrowth is weak and below potential) a point againvery well articulated by the mid-year economic analy-sis of the government.

So how does the Budget get around this impossi-ble trinity: higher public investment, yet continuedfiscal consolidation and an underlying fiscal stance

that is not procyclical?There is a solution! An asset swap on the public-

sector balance sheet, that raises more revenue fromasset sales and ploughs those proceeds into infra-structure assets.

The government has a slew of assets on its balancesheet. No one is arguing for privatising all these assets.But if the government were to gradually reduce itsstake across various public sector enterprises, whilemaintaining a 51 per cent stake, sell its assets withinSUTTI which serve no strategic purpose continueto sell spectrum, and think creatively by selling/leasingthe large quantum of its land holdings, for example, itcould mop up a very large quantum of revenue over thenext two to three years. At last count, the value of theseassets, even while maintaining a majority stake for thegovernment, was easily above five per cent of GDP.

So what the government needs is a predictable plan say of 0.8-1 per cent of GDP for the next 2-3 years ofasset sales that are directly ploughed into publicinvestment such as highways, roads, bridges, ports,airports to offset the private sectors inability tofinance this infrastructure. This allows authorities toraise more funds for public investment without bust-ing the fisc.

To be sure, this is not a case of selling the family sil-ver. Instead, viewed more holistically from the public-sector balance sheet, this is simply an asset-swap, fromcurrent holdings in PSUs into, arguably, more produc-tive assets that will boost productivity and growth.

This also has benefits from a flow perspective. Ifincremental fiscal consolidation is achieved largelythough incremental asset sales, there is no negative fis-cal impulse on the real economy. In most countries ofthe world, asset sales are below-the-line financingitems and do not count towards the deficit, becausethey are not contractionary, like taxes or duties, and aresimply an exchange of assets between the public andprivate sector. So if next years fiscal consolidationfrom 4.1 per cent to 3.6 per cent of GDP is achieved byincreasing asset sales by 0.5 per cent of GDP over thisyears outturn, the fiscal will not be imparting a nega-tive impulse on the economy, unlike if the consolida-tion was achieved through higher taxes/duties or low-er expenditures. In other words, the underlying fiscalstance would not really be contractionary, even as theheadline deficit is reduced to re-assure investors andratings agencies that the fiscal goal-posts are not beingchanged in the middle of the game.

So an asset swap on the public sector balance sheetwill allow the government to have its cake and eat it too:boost public investment, stay on the fiscal consolida-tion path it had agreed to in the July Budget, and yet notimpart a negative fiscal impulse to an economy whengrowth is weak.

Of course, the Budget must also do whats less con-troversial: to compensate for the loss of inflation tax,excise and import duties on oil products must rise, sothat these funds can be ear-marked for more infra-structure investment, rather than being passed on tohouseholds to be consumed. Given the oil-subsidiesthat existed, households never really experienced oil at$120. Why, then, should they get the full benefit whenoil is at $50? And the government must better target foodand urea subsidies to derive savings on those fronts.

But the key for the Budget is to jumpstart publicinvestment while staying on a path of fiscal consoli-dation. A judicious use of its balance sheet will allow thegovernment to do both. It must now seize the moment.

The writer is chief India economist, JPMorgan

Is the Budget facing animpossible trinity?An asset swap can simultaneously boost public investment, reducethe fiscal deficit and keep fiscal policy from being pro-cyclical

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