India could very well be in stagflation situation before end of next fiscal: Mythili Bhusnurmath

The stress tests are showing that the fiscal conditions of the most indebted states in India may deteriorate even further and those may require corrective measures. That is what the RBI is saying in its bulletin. How are you reading it? How precarious is the situation?
Well the situation of almost all of our states is not very great and these particular five states that they have mentioned are among the 10 states that the RBI has listed where the fiscal condition is not very satisfactory.

Ironically, just as RBI has pointed to these states, the IMF once said to the Government of India that our national debt to GDP ratio is also unsustainable. So how does one look at it? Yes the fiscal conditions of the states are not good. The five most stressed states in terms of fiscal condition particularly where the debt to GSDP ratio (Gross State Domestic Product Ratio) is very much above the desirable level are Bihar, Kerala, Punjab, Rajasthan and West Bengal – the five most stressed states.

It also points to the dangers of the past that the states are spreading in terms of falling share of the state-owned revenue. An increasing amount of freebies are given by the states and two particular states Rajasthan and Chhattisgarh have gone back on the New Pension Scheme and have decided to go back to the old Pension Scheme. The Centre moved away from the old scheme and introduced the NPS because it found the pension scheme was completely unsustainable.

But Rajasthan and Chhattisgarh have gone back to the old pension scheme. So it is a combination of things that the states are doing. The fact that their own revenue has been falling, that they have been giving a lot of freebies and their subsidy burden has been grim. There are two kinds of subsidies – merit and non-merit subsidies. Merit subsidies help the larger economy and perhaps one can live with them but non-merit subsidies given in states like Punjab like free electricity are completely non-merit subsidies and have deleterious effects in the long run.

So the position of the states is not satisfactory and they need to do much more, particularly to increase their own share in the total revenue. Covid has not helped any of the states, it has not helped the Centre either. These are hard times that they have to live through but remember also in all this, the constitution limits the borrowing power of the states.

In fact under Article 293 (3) of the constitution no state government can borrow on its own without the Centre’s permission which is why we have seen in the past few months, constant ruckus between the Centre and the state governments with some state governments wanting to raise more money, borrow more and the Centre laying more and more conditions and imposing restrictions on them.

This is part of fiscal federalism but none of this takes away from the fact that the Centre as well as the states need to improve their tax to GDP ratio and bring down their debt to GDP ratio. In the case of these particular five states that the RBI bulletin had identified, the position is particularly adverse and needs to be speedily remedied.

You spoke about the Indian growth story as well. It is not just the problematic states that we are talking about with a growth rate of 8/7% in FY22. The Bulletin also says that India’s Gross Domestic Product has surpassed states pre-pandemic level by 1.5% and the recovery remains robust in FY23 so far. Does this match your reading of the economy? Are we placed to avoid stagflation?
Well this is going to be a little difficult because there are talks about large parts of the world particularly the US is possibly heading into recession. I do not think India is heading into recession because clearly we are growing, even if the 8.7% comes on the back of a contraction to 6.6% in the previous fiscal.

The fact is we are nowhere near a recession, we are growing. We have lost two years but now we have reached the pre-pandemic level. But if you look at inflation and if you look at the combination of inflation and growth, what does stagflation mean? Stagflation just means high inflation and stagnant growth and from that perspective, there is a very clear possibility of India heading to stagflation because inflation has now reached the levels where it is going to become an impediment to growth.

The 8.7% must be taken with a pinch of salt. It comes on the back of a contraction in previous fiscal going forward growth as we are nowhere near our potential. It will be perhaps stagnant to that extent. Stagflation is the combination of stagnant growth and high inflation. We could very well be there before the end of the next fiscal.

ET Now: The problem of the big overdues of power distribution companies has also been spoken about in the bulletin and it has been around this problem has stood for a long time where growth concerns rise, crude oil prices go up, cold shortages become the order of the day. How much bigger do you reckon this problem is going to balloon into?

Well this has been a big problem for India not just now but in the past many years. There have been successive attempts to clear up the mess in the power sector we have reforms and discoms but really it has not got us very far simply because in the democratic kind of a set up, there is an enormous temptation of state governments to offer freebies.
Every time, elections come around, one will find incumbent governments and even other political parties offering free power, free water and loan waivers. This is something that perhaps comes with democracy and until electors are sufficiently educated and understand that nothing comes for free and if today I am getting free power, that possibly means no power tomorrow, it will continue.

This is going to be a tough lesson and state governments must learn to become more responsible but this cuts across all political parties. We have seen even the ruling BJP in many of the state elections offer farm loan waivers. As I said, there is no free lunch and if one offers these kind of freebies, the chickens are going to come home to roost.

Democracies will have to learn that populist measures cannot take you very far. They may be good in the short term but long term, there is disaster and that is a learning that must come across for all political parties. Power sector reform, loan waivers are classic examples of freebies