A makeover for North Block

The Indian economy faces tough challenges, but the pressure today is more on Mint Road

A recent conversation with a Mumbai-based financial market analyst provided an interesting perspective on perceptions of how the challenges before the Indian economy were being managed by North Block, headquarters of the Union finance ministry, and Mint Road, headquarters of the Reserve Bank of India (RBI). In the past, the usual response from financial analysts, based in Mumbai, would be marked by complaints about how North Block was getting most things wrong, complicating problems for the central bank. In contrast, Mint Road was seen to be doing its best to contain those damages.

The tone of the response last week was different. There was hardly any complaint about the finance ministry, which was seen to be functioning coherently, responding to the challenges quickly and taking steps to make the best of a bad fiscal situation by trying hard to rein in the deficit and, therefore, its borrowing. The RBI too was taking steps, often by shocking and surprising the markets. But there was a tinge of dissatisfaction about the way it was dealing with the rupee and inflation at a time when the situation was getting more difficult by the day.

What has brought about this change and a perception reversal of sorts in how the RBI and the finance ministry are seen to be managing the economy? Mind you, this reversal was not noticed even a year ago. The RBI was seen to have managed the Covid impact without any major problem and it was the finance ministry’s role in Covid management that came in for some attack. 

To be sure, the change in the relative perception of Mint Road and North Bock has coincided with the worsening of the economy. It is now widely accepted that the dangers of a twin deficit loom large before the Indian economy. Economists had been warning of both the dangers for the last couple of months. But now the finance ministry’s monthly economic report, released in June, has hinted at the risks of both a widening current account deficit and a fiscal deficit. Perhaps this may well be yet another factor that has endeared North Block to the analysts of Mumbai.

Indeed, that report was one of the most candid admissions of incipient economic risks, coming as it did from the finance ministry after a few years of brazen attempts at hiding even the obvious problems under the carpet. It was both worrying and reassuring. Worrying, because the challenges of managing the economy were becoming more complex and formidable. Reassuring, because the government seemed to be conscious of the problems and was ready to take the necessary corrective steps. You may quarrel with the effectiveness of those steps, but you couldn’t complain that the finance ministry has not responded to the challenges.
 

Illustration: Binay Sinha

One aspect of the gravity of that challenge emanated from the data of the two deficits in the last four decades. Both the deficits have been a cause for serious concern for the Indian economy in different phases of this period. But only twice in the past four decades did the two deficits widen at an alarming pace almost at around the same time. Those were in 1991 and for about two years from 2011 to 2013. 

The current account deficit had risen to 3.1 per cent of gross domestic product (GDP) in 1990-91, even as the fiscal deficit had soared to 7.6 per cent of GDP. The next time such a confluence of twin-deficits endangered the economy was between 2011 and 2013, during the US Fed’s taper tantrum days. That period saw the gradual build-up of the current account deficit, even as the fiscal deficit stayed well above the 4 per cent mark for those years. The current account deficit for this period was also over 4 per cent of GDP. And even though the capital account surplus held firm at over 2 to 2.5 per cent, the overall effects on the external economy were adverse. 

The prognosis now is that India may well be entering into a third phase when both the fiscal deficit and the current account deficit would widen, adding to the woes of the government and the RBI. In 2021-22, the Centre’s fiscal deficit was maintained at 6.7 per cent, while the current account deficit was 1.5 per cent. But there are clear signs now that during 2022-23, the current account deficit may double to over 3 per cent of GDP and the fiscal deficit may just manage to stay below 6.5 per cent.

Within weeks of the presentation of the Union Budget for 2022-23, serious doubts surfaced over the government’s ability to stick to the deficit target of 6.4 per cent of GDP. Fresh commitments on higher expenditure were made, including those for extending the free food ration scheme till September and providing more concession for cooking gas cylinders under the Ujjwala scheme. At the same time, the revenue side was adversely impacted by decisions to cut cess on petrol and diesel and reduce Customs duty on a few commodities. According to one estimate, the total impact of these measures on the government’s budget was about Rs 3.3 trillion or about 1.3 per cent of GDP. This cast a shadow on the government’s ability to contain its fiscal deficit.

But the mood changed by the first week of July. A series of measures to bolster the government’s revenues (including the levy of a cess on upstream oil companies and a tax on fuel exports) meant that the additional burden of Rs 3.3 trillion could be almost halved. And with the tax revenue buoyancy in place, the task of fiscal management began to look less difficult, even as the finance ministry remained confident of meeting its higher capital expenditure target.

In contrast, the RBI appeared to be struggling with fulfilling the tasks of containing inflation and stabilising the fall in the rupee, even as its foreign exchange reserves dipped by about $19 billion in the first three months of 2022-23. With the frequent clamour for a more proactive intervention by the Monetary Policy Committee to meet its inflation target of 4 per cent, the RBI is certainly facing more pressure to perform its duties as the apex body in charge of monetary policy and inflation management. North Block must be heaving a sigh of relief that, in spite of the tough situation, it has not suffered the kind of image management problem that Mint Road has to deal with. How long that lasts, however, is a moot point.