Using GDP for fiscal policy is like shooting in the dark. It can limit govt’s crisis response

In India, measuring the debt/GDP ratio is fraught with challenges because GDP measurement is unreliable. 31 July, 2024 The Print

In her 2024 Union Budget speech, Finance Minister Nirmala Sitharaman said, “From 2026-27 onwards, our endeavour will be to keep the fiscal deficit each year such that the Central Government debt will be on a declining path as a percentage of GDP.” The Finance Secretary TV Somanathan reiterated the same in an interview with ThePrint. However, the debt/GDP ratio is not a reliable basis for fiscal policy owing to problems in GDP measurement. The government may also end up committing to a pro-cyclical fiscal policy—running larger deficits when times are good, and having limited fiscal space during bad times. This limits the government’s ability to deal with crises, and can have adverse effects on economic outcomes.

The measurement challenge

In India, measuring the debt/GDP ratio is fraught with challenges because GDP measurement is unreliable. If we can’t measure GDP accurately, we are shooting in the dark with our fiscal deficit targets potentially leading to misguided policy decisions. Additionally, any medium to long-term fiscal strategy will involve making projections on the debt/GDP ratio. These are extremely vulnerable to interest rate and GDP growth rate assumptions. If the government can borrow at a lower rate, then it has more room for adding to its debt. For this to work, the government will have to consider a variety of interest rate scenarios, and outline its fiscal strategy accordingly. There is also an incentive to keep interest rates low to ensure smoother fiscal management.

Interest payments as a percentage of revenue receipts come from well-defined transactions. If 40 per cent of government revenue is used for interest payments, it gives us a clearer picture of the remaining fiscal space for other expenditures. Revenue receipts also provide a more accurate picture of the government’s “income” compared to the GDP, as they directly reflect the actual funds available for spending, unlike GDP, which encompasses the total economic output but doesn’t directly translate into government revenue.

How will the glide path play out?

Let's consider a straightforward example: For the past decade, the government has earned Rs 100 in revenue and spent Rs 140 each year, resulting in an annual fiscal deficit of Rs 40. With a constant GDP of Rs 1,000, the fiscal deficit is 4 per cent of GDP. The government borrows Rs 40 each year to cover its expenditures, accumulating a total debt of Rs 400. Consequently, the debt/GDP ratio has risen to 40%. Historically, the government has aimed to keep the fiscal deficit as a percentage of GDP below a certain threshold. The latest budget speech indicates that starting from FY27, the government intends to adjust the fiscal deficit to reduce the debt/GDP ratio. Now, let’s explore how this glide path would function in different economic scenarios:

In a good year: During economic booms when GDP rises, the debt/GDP ratio should ideally decline. The government can afford to run a larger fiscal deficit without significantly increasing the debt/GDP ratio, which is considered pro-cyclical.

In a bad year: When the economy is struggling, GDP falls, and the debt/GDP ratio tends to rise. In such conditions, the government must maintain a very small fiscal deficit to prevent further increases in the debt/GDP ratio. This is also pro-cyclical.

Targeting the deficit based on the debt/GDP ratio risks encouraging larger deficits during good times. This limits the ability of governments to respond to a crisis and undertake large-scale welfare spending in bad times.

The fiscal policy challenge

In challenging circumstances such as wars, global crises, or pandemics, it is almost impossible for governments to not respond. Take the recent example of Covid-19. The government needed to increase its welfare spending to relieve some of the stress that households and firms were facing. In the Organisation for Economic Co-operation and Development (OECD) countries, large amounts of spending were incurred to soften the blow of reduced economic activity. Our fiscal depth was lower, and hence we could not undertake the scale of expenditures that the OECD countries did.

Governments have two strategies in such times—they can either run down their primary surplus or borrow from financial markets. Both options are feasible if fiscal policy has been conservative in good times. A primary surplus allows the government the room to take on deficits. A good fiscal track record makes the market comfortable in lending to the government. Many will claim that the latter is not a problem in India.

However, a large amount of government borrowing is due to financial firms being forced to invest a certain proportion in government bonds through statutory liquidity ratios or other investment guidelines. The extent to which the government will be able to continue to borrow from the market at low interest rates as the economy matures remains to be seen. In any case, a captive bond market is not a strategy to count on. Further, spending in good times can exacerbate the economic boom. Not spending in bad times can worsen the recession. The impact of such austerity is felt most significantly by low-income households who rely on welfare spending.

Our public finances will be on a sounder footing if we do not rely too heavily on a poorly measured indicator such as GDP, and commit instead to a counter-cyclical fiscal policy.

NPS-Lite can streamline welfare funds & pension schemes for the poor—with 2 key reforms

To widen pension coverage in the informal sector, India must use existing infrastructure to its full extent. The mechanism in place for the NPS can be used to implement other schemes as well.

The Print
17 July 2024

Informal sector workers have limited benefits in the absence of any provident fund or gratuity. What solutions then can the Indian government come up with to help them build wealth for old age? When there is no food on the table, one cannot discuss savings.

However, the informal sector is quite heterogeneous, and to the extent that there is some saving capacity among workers, could they be brought into the fold of pension schemes?

Encouraging voluntary contributory pensions is an important strategy to achieve greater pension coverage in the informal sector. There are two possible reforms the government should consider. First, create an enabling framework for Union and state governments to plug into the National Pension System-Lite (NPS-Lite). Second, widen the variety of drawdown policies for those exiting the workforce at the age of 60.

Using existing infrastructure

Government employee pensions are provided through the NPS. Under this framework, a central record-keeping agency (CRA) documents the pension contributions, licensed fund managers handle the money, NPS Trust holds responsibility for the assets and funds, and the regulator — the Pension Fund Regulatory Development Authority (PFRDA) — maintains the sanctity of the system.

This infrastructure is readily available for use in any other scheme as well. It was used to set up the NPS-Lite in 2009. Through NPS-Lite, informal sector workers can use the same set of institutions as government employees to manage their pension savings.

If a government—Union or state—wants to start another pension scheme, it should consider plugging into the NPS ecosystem. In fact, this was the initial goal of the NPS.

For example, if a state government wants to start a pension scheme for its constituents, it should be able to open NPS-Lite accounts for them. The objective of the sponsor (in this case, the government) should be to identify those eligible and steer their contributions to the NPS-Lite.

The government could easily provide co-contributions to incentivise those taking up the scheme. It could choose a reliable pension fund to manage the contributions so that the informal sector workers are able to enjoy the same level of transparency and regulatory scrutiny of their investment as the formal sector workers. If a worker moves to another state, the pension account stays with her. This is a better strategy than starting a new scheme with a separate fund for each state.

The Ministry of Finance and the PFRDA need to create an enabling framework that reduces friction for a state government to plug into the NPS ecosystem. On the other hand, the Ministry of Labour and Employment needs to use the existing NPS infrastructure instead of starting separate welfare funds.

Reforming drawdowns

The distinguishing feature of a pension scheme from any other savings product is the periodic payment (also known as an annuity) that a pensioner receives from retirement to death. Without this, the corpus in a pension account is not too different from the corpus in a savings account.

The current NPS framework requires a member to purchase an annuity from a licensed service provider at the time of retirement. The member has to use at least 40 per cent of the accumulated surplus to purchase an annuity plan, which continues to pay a specified amount until death.

The problem with annuities is that while everyone pays the same premium at retirement, only those who live longer benefit from the payment. Essentially, those who live longer get subsidised by those who die early. This becomes an important issue in the case of informal sector workers, whose life expectancy is likely to be lower than those in the formal sector. We don’t want a situation where the poor are subsidising the rich.

The PFRDA needs to invest in infrastructure that can price annuities for NPS-Lite customers more accurately. It can build life tables that reflect the appropriate mortality scenario for the informal sector. This may require a tie-up with the birth and death registration system.

Another approach is to allow phased withdrawals from the pension account based on specific formulae. The PFRDA has already proposed setting up a Systematic Lump Sum Withdrawal facility for NPS account holders. This could be extended to the informal sector workers.

Why not Atal Pension Yojana?

The PFRDA offers another scheme called the Atal Pension Yojana (APY), which guarantees a pension if the member contributes continuously for a specific number of years. The appeal of the APY over the NPS is that it provides a guaranteed return. However, one must not forget that both contributions and the pension amount are capped in the APY. It is not possible to contribute more to get a higher pension. This forces the informal sector workers to sign up for pensions that are low in nominal terms.

The NPS-Lite, on the other hand, does not provide a guaranteed return but offers the possibility of higher pensions. It also offers various investment choices to its members.

The other option is to start separate funds or schemes for specific categories of workers. However, several such funds in India have seen poor governance and even fraud. The funds are not “regulated” in any sense. On the other hand, fund managers for pension schemes regulated by the PFRDA are under constant scrutiny and have to disclose the net asset value of their funds on a daily basis.

So far, we have not seen poor governance by these fund managers and the PFRDA can be relied upon to conduct its supervisory function appropriately. India has been a proponent of state involvement in building public infrastructure, from digital payments to e-commerce. It already has the “rails” for pension systems; all it has to do is leverage them.

Does India need a new poverty line? Depends on what we’re measuring it for

A reasonable question to include in poverty measurement exercises would be the extent to which a person can carve out a life outside of the tentacles of the Indian state.

The Print
3 July 2024

Should we measure poverty differently? This was the question raised by the chairperson of the Economic Advisory Council to the Prime Minister a few weeks ago. The answer to this depends on what we are measuring it for. In a country where welfare benefits are available only to those “eligible”, defining and measuring eligibility becomes important. Poverty in this context may be different from poverty when it is seen as a general reflection of how our politics and economics are performing. It is important that we allow for heterogeneity in the definition of poverty, and invest in statistical machinery that can capture the definition of poverty we agree on.

Poverty thresholds in India

The typical measure of poverty is whether a household (or an individual) has enough to make ends meet. This is not as simple as it sounds, for you would ask, what does it mean to make ends meet? Different committees in India have taken different approaches to answer the question.

Until 2009, our view was that the poverty line should be based on calorie intake – how much money does an individual need to consume around 2,000 calories per day? The Tendulkar committee expanded this definition in 2009 to include non-food expenditures like health and education. According to this committee, poverty translated to measuring whether an individual had less than or equal to Rs 447 per month in rural areas and Rs 579 in urban areas. This was later revised to Rs 816 per person per month in rural areas and Rs 1,000 per person per month in urban areas in 2011. The assumption was that if you have this much, then you are not technically “poor”. Since then, there have been other committees (such as the Rangarajan committee, and the Socio-Economic Caste Census) that have addressed this question. The official thresholds, however, continue to be those suggested by the Tendulkar Committee.

Measuring poverty for welfare transfers

There are three issues to bear in mind as we redefine poverty for the use-case of welfare benefits. First, we should be careful to not judge the numbers with our urban lens. Many of us will most likely have spent more than Rs 1,500 on a single meal in an upscale restaurant at some point. This makes us scoff at such a minimalist definition of poverty, and the current thresholds do seem to be very low benchmarks.

The reality across the country, however, may be very different. There is a standard concept of purchasing-power-parity when comparing nations across the world. The same $1 buys very different things in the United States and India. This concept needs to be applied to measuring the threshold that a standard basket of goods will buy across different parts of the country. Perhaps a single definition cannot encompass the regional economic heterogeneity in India.

Second, it is not trivial to arrive at an appropriate basket of goods. One way to think about this is that poverty is often relative to everyone in society. If India’s GDP per capita were to magically increase by 10 times, we would still have a “bottom of the pyramid” that finds itself left out. One conceptualisation of a poverty threshold is an income that is less than some per cent of the median income of the society in which the person lives. In either conception of poverty, thresholds should vary by region. It should also be up to local governments to determine eligibility for the schemes that are designed and administered by them.

Third, and most important, is the question of measurement. The exercise of measuring poverty requires a statistical machinery that can capture household expenditures and incomes – regardless of the definition one uses. It requires a Census that gives us a sampling frame so that appropriate samples can be drawn. India shows no sign of conducting a Census, so we don’t even know how many people exist in India, and what our population growth or rural-urban composition is. In the absence of this basic machinery, it is hard to imagine how the best-crafted conceptual approaches to poverty measurement are going to get translated on the ground.

An expansive definition of poverty

One of economist Amartya Sen’s contributions was to frame development as a process that expands the freedoms of people. The substantive question of poverty should be seen in the same way. In this scheme of things, people are poor when they have limited agency to even aspire for a life different from the status quo.

In India especially, this translates as the freedom to check out of the Indian state. The true marker of escaping poverty today is the extent to which you can ignore the state in your daily life. This means building private islands with one’s own security, sports clubs, schools, water, air-purifiers, and doorstep services ranging from groceries and food to banking. This means “knowing a guy” who can get things done. Roads will cave and roofs will fall, but at least the police is more likely to be polite, and a private hospital with lower wait times and cleaner beds will be available.

Assuming that state capacity in India shows no signs of improvement, a reasonable question to include in Poverty measurement exercises would be the extent to which a person can carve out a life outside of the tentacles of the Indian state. There are two questions that household surveys should consider.

First, in the last few months, how many times have you had to deal with the Indian bureaucracy to obtain what was legally yours? Second, in the last five interactions with any government office, was the government employee rude to you? The responses to these questions will tell us the status of poverty in India. The greater the ability of people to check out of the state, the greater their prosperity. Of course, we will have truly emerged out of poverty when these questions will no longer be relevant. That is the goal we should aspire for.