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Downsize the government

If we are to come out of this mess not too badly bruised, focused spending - and not merely more spending - is key. When it comes to governments, bigger is not necessarily better.

india Updated: Mar 05, 2009 22:10 IST

The latest cuts in overnight interest rates for banks are accompanied with the now-customary exhortation that they should, in turn, bring down the cost of credit for the economy at large. The central bank’s admonitions have been largely ignored through the five reductions in its policy rate to 5 per cent from 9 per cent from October 2008. State-owned banks are lending to their prime customers at around 12 per cent and private banks charge up to 4 percentage points more, not significantly less than a year ago. Partly because banks don’t seem able to shake off their aversion to risk and partly because the government’s humungous borrowing programme is overwhelming the money market.

Of the Rs 390,000 crore the Reserve Bank has pushed into the system since the global credit market seized up, the government will have moped up Rs 326,512 crore in the year to March 2009. Next year, the government intends to borrow another Rs 332,835 crore. Add to this the leeway states have been given to borrow in excess of their medium-term targets. Financing the Centre’s fiscal deficit — optimistically projected at 5.5 per cent of the GDP — is crowding out lending to other sections of the economy, explaining the downward stickiness of interest rates. As the central bank nears the end of its rate-easing cycle — and that does not appear too far off — interest rates will face mounting pressure to climb. Beyond a point, the pressure will also be felt on the price line.

Which is altogether not a bad thing. A combined central and state deficit of 11 per cent and a tax-to-GDP ratio of 12 per cent mean the government is spending every fourth rupee in India. Bumping this up to take the slack in the economy is a copybook response. The tricky bits are the quality of government spending and the long tail in scaling it back. Deficit financing is self-limiting if the government’s working expenses edge out investment by companies, as is happening at this point. If we are to come out of this mess not too badly bruised, focused spending—and not merely more spending — is key. When it comes to governments, bigger is not necessarily better.