Amidst this season of poll promises, one common scheme announced by both the Bharatiya Janata Party (BJP) and the Indian National Congress (INC) is income support through direct cash transfer. Wrapped in different names, sizes and targets, the broad cost and the operational feasibility of these plans have already been widely debated. We endeavour to gauge the impact of these plans, if implemented, on the core economy, through growth, fiscal and inflation. Given the impact is entirely contingent on 1) the time taken for maximum or full implementation and 2) the level and pace of operational scaling-up during this period, we examine scenarios which depict possible paths of implementation and the corresponding macroeconomic impact.
Growth
According to a September 2017 study published by the Development Research Group (DRG) of the RBI, for a 10% rise in government expenditure, direct consumption boosts real Gross Domestic Product (GDP) by 85 bps in the first year vs. transfers to households (whether to all or only the bottom 70%) only by 30 bps, with the latter’s impact declining over time. The reasons are:
– Unlike direct government consumption, transfer increases the disposable income of households (HHs), part of which is saved (also as cash) depending on the marginal propensity and only the rest is spent on consumption after paying any taxes, etc.
– HHs consume more agricultural and industrial goods, which have a lower weight in output (~46% in FY19), while government consumes more services. This reduces the impact of transfers on GDP, tax revenue growth, and therefore investments which determine future growth. One could argue the resulting lower fiscal balance creates higher growth impulse, but 1) the damper direct GDP impact more-than offsets this and 2) the lower skilled and semi-skilled employment generated via household expenditure reduces second round demand creation and future growth.
If we paint inflation with the same brush, the impact on the Consumer Price Index (CPI) from any income support plan would be higher than direct government consumption as goods have a much higher weight (76.7%) in the inflation basket than services (23.3%). Further, given the sharp drop in food prices (read farm distress) in the last few years, any incremental consumption could be more heavily skewed towards food items, potentially channelling reflationary pressures there. Rural food & beverages have a weight of 29% in the All-India CPI basket.
So far, the merit of direct cash transfers has largely been evaluated only vs. the current system of multiple subsidies, as it is widely acknowledged to plug leakages and thus better for growth. However, the impact on growth of direct transfers vs. other forms of public/private measures needs to be studied and debated more.
The fiscal, consumption and inflation impact
The BJP’s Pradhan Mantri Kisan Samman Nidhi (PM-KISAN), initially launched targeting families of ‘Marginal & Small’ farmers as per the FY20 interim budget, will be extended to all the farmer families as per its election manifesto (Figure 1).
Figure 1: BJP’s PM-KISAN
The key questions are 1) what is the fiscal cost?, 2) how much will this boost household consumption expenditure and 3) what will the likely CPI impact be? The total fiscal cost will be 0.42% of GDP in FY20, if implemented fully (Figure 1). Even if we assume the number of marginal & small land holdings increases in the next agriculture census (which will have data for FY21) by the same amount it did from 2010-11 to 2015-16, the additional cost will only be ~0.02% of GDP. Moreover, the 2020-21 agriculture census is not likely to be released before 2023, based on previous releases.
To answer the second and third questions, we need to ascertain households’ Marginal Propensity to Consume (MPC), which is the amount of consumption spending created from every additional rupee of income. The RBI study mentioned previously notes the top 30% of HHs contributed to 84% of HH savings, implying very high consumption for HHs in the bottom 70%. It also notes 68% of all HH earnings is spent on consumption (implying high average propensity to consume). Our own estimate of MPC, derived using linear regression of growth in domestic HH consumption expenditure and gross disposable income as per the new national accounts series (R2 = 0.74), was ~87%. Assuming a slightly conservative MPC of 80%, Figure 2 depicts the likely increase in private consumption generated by the plan, over and above the previous five-year-average growth of 12% (0.53-0.62%), and the likely CPI impact (15-45 bps) ceteris paribus and depending on the pass-through from consumption growth to CPI.
Figure 2: Likely impact of BJP’s PM-KISAN scheme on consumption and inflation
Source: CEIC, Agriculture Census 2015-16, India Budget, BJP election manifesto, IDFC MF Research
The INC’s Nyuntam Aay Yojana (NYAY) guarantees a cash transfer of Rs. 72,000 per year to ~ 5 crore (the poorest 20%) families, after a year of design, pilot & testing. INC estimates it to cost <1% of GDP in the first year of implementation and <2% of GDP in the second year and thereafter. We explore multiple scenarios, with varying level and pace of implementation, to gauge the likely economic impact (Figure 3).
Figure 3: INC’s NYAY
Source: India Budget, INC election manifesto, IDFC MF Research. Note: In each of the three scenarios, we assume 3% of people move out of poverty each year, 5% of FY20 subsidies are discontinued from FY21 and the nominal GDP grows by 11% each year.
Again, assuming an MPC of 80% as before, Figure 4 depicts the likely increase in private consumption generated by the plan, over and above the previous five-year-average growth of 12% (0.48-1.95%), and the likely CPI impact (12-146 bps) depending on the pass-through from consumption growth to CPI.
Figure 4: Likely impact of INC’s NYAY scheme on consumption and inflation
Source: CEIC, India Budget, INC election manifesto, IDFC MF Research. Note: PFCE is Private Final Consumption Expenditure
- Needless to say, the more time it takes for maximum implementation, the lesser the cost as nominal GDP grows and people move out of poverty each year. The possible disincentive for people to move out of ‘poverty’ to remain beneficiaries of the scheme is not considered here for the sake of simplicity
- The CPI impact is also lower and smoother (i.e. more evenly spread out) with higher implementation time
- While the PM-KISAN scheme is already in the execution phase, the NYAY scheme is still in the strategy & design phase where the finer details such as sources of funding, non-merit subsidies to discontinue, process to identify and verify the target population, estimate of the number of people who move above the scheme-threshold each year, etc. are being chalked out
- Therefore, we see the range of outcomes for the fiscal and inflation impact of NYAY at this stage is higher than for PM-KISAN, although the quantum of impact seems higher due to NYAY’s higher transfer However, the actual economic impact will entirely depend on the final size of target population identified, the level and pace of implementation explored using the above scenario-based framework
Ultimately, it is worth reminding ourselves all economic resources are limited. For every additional rupee one spends, a rupee is parted with or not received by another. It is essentially only channelisation, but this bigger picture might become visible only in the longer term. Thus, for a holistic assessment, one needs to also consider the longer term and the population not immediately benefited by such government schemes. We need to see more than meets the eye.
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