As long as India maintains fiscal responsibility, there may come a point where the credit ratings by international agencies will lose their significance altogether, says T.V. Somanathan, finance secretary and secretary of expenditure, Ministry of Finance, Government of India.
In an exclusive interview with Outlook Business, he said, "Rating agencies say what they say, we live with that. I do not expect anything from the rating agencies. They will do what they do, we will do what we must do."
Furthermore, the secretary talked about his thoughts on India's taxation policies, influence of Indian bonds getting included into global indices, and government's fiscal consolidation path, among other macroeconomic issues.
Edited Excerpts:
Since private investments have only recently picked up, do you think the fiscal deficit target of 4.5 per cent can be achieved at a sustainable basis without a significant rise in private sector expenditure and hurting India’s growth momentum?
First, I think the current growth momentum can be sustained even at a slightly lower fiscal deficit, because I do not see the absolute amount of capital expenditure declining from present levels. That is 10 per cent revised to 9.5 per cent for the current year and 11.1 per cent in the next year.
I do not think that the consolidation will come at the expense of reducing that. It will come partly through increased revenue, increased denominator in the GDP [gross domestic product] and perhaps through some compression of other expenditure as a proportion of GDP. So, I do not think we will see any reduction in capital expenditure levels.
What private capital expenditure can do, if it increases, is to push up the rate of growth. Now, if we do not get it, we will probably remain at the present level and not go up further.
Do you believe that if this government returns to power, it would be able to just achieve the forgotten Fiscal Responsibility and Budget Management (FRBM) target?
I am not speaking on behalf of the government here because it is a speculative thing for me to say. What I believe is that the whole philosophy perhaps needs to be revisited. I think the old philosophy of a fixed 3 per cent target as a permanent fixed objective is questionable.
India with its real growth rate, its rate of inflation and its interest rate is capable of a particular level of sustainable fiscal deficit. That figure is greater than 3 per cent, without even leading to an increase in debt, because we have a nominal growth rate which is likely to be in the region of 10 per cent to 12 per cent over the coming years. Even if you take 6 per cent growth and 4 per cent inflation, that is 10 per cent. At 6.5 per cent and 4 per cent, it is 10.5 per cent. So, it is very likely that India will sustain a nominal growth rate of 10 per cent-plus.
With 10 per cent nominal growth, you can run more than a 3 per cent fiscal deficit and still have a declining debt profile. So 3 per cent is, I think, too austere for India's circumstances as it is today. And if pursued, it may curtail our potential growth below what is possible. But the real optimal rate is probably greater than 3 per cent. It is closer to 4 per cent-plus. And this is my personal opinion.
India’s ratings have not changed for a long time. Suppose if we do get an upgrade, what kind of impact will it have on India’s growth profile?
Rating agencies say what they say, we live with that. I do not expect anything from the rating agencies. They will do what they do, we will do what we must do.
An upgrade, however, will help in terms of lowering costs of capital. But I am also getting a feeling that a stage will come soon when if we continue to be fiscally prudent, these ratings will become irrelevant.
If you do well enough, the markets will respond. They will say okay, it is a good opportunity. It is technically not rated like this, but actually it is that. So let us invest. But for that, we have to be very good. We should be prudent for our own sake, not because rating agencies are watching.
At what point should the government focus on increasing India’s tax-to-GDP ratio to maintain high level of investments? Talks of rationalising goods and services tax (GST) slabs have been on for a while now.
Whether rationalising the GST slab will lead to an increase or reduction in the ratio is a moot point. The rates were brought down in 2019 below the revenue-neutral rate. It is a difficult task before the GST Council because in rationalisation, every member of the public likes one half of the rationalisation, where something is going down. Nobody likes the other half of the rationalisation, where something will go up. So, this is a challenge.
Some experts believe that India taxes its middle class more at the lower end of the tax slab when compared with other economies. For example, 30 per cent on Rs 15 lakh. This results in decreased consumption and demand potential. Do you think this is a valid argument?
I am not sure if it is completely valid. Taxes in India do give you something. It is common for the middle class to think that they get nothing from it but try living in some uncivilised part of the world. You will realise what value you get. You are able to walk on the street, without fearing that you will be killed on your way home. Safety is a huge public good. Relative to a lawless society, we are far better off.
Can we be better? Of course we can be better. We should do better with our tax money. But it is not true that our limits are very low. In the US, even with an income of $3,000, you start paying taxes. So it is all relative to per capita income. It is not that low and Rs 15 lakh, I would say is reasonable if you aim to be a developed country.
There is a buzz of premiumisation of the Indian economy these days. At the higher end, people are purchasing premium products but rural demand is still low. What do you think is the reason behind this divergence and do you think that the government is worried about it?
It has become a cliché to say the rich are getting richer and the poor are getting poorer. It is probably true the rich are getting richer. But the poor are not getting poorer. Now, how do you increase the consumption standards of the middle class and the poor? That is a valid policy challenge for the government. And I think the answer lies in creating more productive jobs. That is one.
And second, in ensuring that the rich pay their taxes. These are the two methods by which I think this can be addressed. If you look at income tax, some of them [the rich] were using investment-linked insurance as a way of avoiding income tax. There were people who were contributing Rs 200 crore to the EPFO [Employees’ Provident Fund Organisation] and enjoying a tax-free interest. Those all have begun to show as dividends in terms of tax collection. GST, of course, also plugged loopholes.
Do you think the government should be able to bite the bullet on farm-income taxation?
Taxation of farm income constitutionally is a state subject. It is open to the states to levy this tax.
Exposure of India’s credit to global investors is now expected to increase after the announcements of its inclusion into global indices. How does this influence policymaking?
India being included in any index has a plus and a minus. The plus side is that the pool of resources will increase, so it is likely to lead to a reduction in interest rates, which we have to pay on government bonds, which in turn will have a positive effect on state government bonds, corporate bonds and general lending rates. Because the demand for our bonds has increased, supply has remained the same. That means interest rates will come down.
However, there is a negative effect. These are passive bond flows. Passive bond flow means that people are investing in a particular index fund. Whatever is the weight of India in that index, they put that much money against that fund. But how much you put in an emerging-market fund is affected by how much you put in other funds. That is a variable which is often arbitrarily affected by global events.
Let me give you a hypothetical event. In a big developed country, a particular person gets elected as president. That sends lot of tremors across financial markets. They react by what they call a flight to quality. These are all behaviours which are given rationalisations by the markets. They are not very rational. In this flight to quality, everybody buys bonds of the very country whose risk has increased, because that country is an international benchmark. So, you suddenly say that I am dumping emerging-market bonds. I am going to fly to quality in treasury bonds of one particular country. The entire emerging-market sector gets downgraded.
It has nothing to do with India. It is not that India has become fiscally profligate…The problem with these passive funds is I may get punished for somebody else's misbehaviour.
In this era of energy transition, green financing still remains a challenge. Investors argue that they have no such incentive to invest in thematic instrument such as green bonds. How will the government address this?
This means that nobody is really serious about green and they are only willing to do it for tax concessions. If I have to pay the same for a green bond as an ordinary bond, I shall take the ordinary bond. That is more flexible for me. The idea of green bonds was not to find a new way to give tax concessions.
Green bonds are supposed to be about people who want to invest in green bonds and want to keep their portfolios aligned to their moral and public policy objectives. It was for people who talk about ESG [environmental, social and corporate governance] and so on.
Why do you think the government is not bullish on disinvestment this year, especially at a time when PSU [public sector unit] stocks are on fire for the first time in over a decade?
The government is looking at a more integrated management of its share assets. We are trying to behave more like a private shareholder. When you hold a share, you choose when to sell based on when you think you will maximise your value.
We have now decided that we will try to maximise the value and share sales will not be an instrument used to fix the fiscal deficit on a timetable.
Do you think the accuracy of crucial macroeconomic indicators gets impacted due to an unrevised base and absence of an updated census?
I would say at the macroeconomic level, I do not think the census is impacting us. What impacts us in a macroeconomic sense is the aggregate population. That can be estimated with reasonable precision without a census. What we do not get in the absence of a census is certain geographical information. How much has urbanized? What is the sex ratio? What is the age profile of the population? These are things which are more important for sectoral policies. Not so much for macroeconomic policy.
This budget talked about developing East India. Is there any way to increase private investments for the region?
I think the onus of bringing private investment into a particular region will fall primarily on state governments. Policies of the government of India are generally all India in nature. I do not think we will come out with a specific FDI [foreign direct investment] policy for the east or the north.
Take Odisha, which is an eastern state, they have actually done pretty well in going out and attracting investment. And this is something which traditionally states like Tamil Nadu, Karnataka, Gujarat and Maharashtra used to do very well. Now, if others in the east are to catch up, they have to start doing that. There are opportunities and some of these eastern states have tremendous advantages in terms of labour supply and the non-unionisation. Every one of them has different pluses and minuses.
