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Who will light the fire?

india Updated: Feb 17, 2009 11:45 IST
N Chandra Mohan
N Chandra Mohan
Hindustan Times
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A year ago, this writer approached Budget 2008-09 as exemplifying the dilemmas of policymaking in a fast-globalising Indian economy. The latest interim budget 2009-10, that is meant to secure Parliament’s approval of essential expenditure till a new government is in, also exemplifies such dilemmas. When the economy has slowed down in an adverse global environment, even a budget presented by an interim finance minister is expected to send out a signal that it is relatively insulated from these developments.

What should be the policy stance of the Indian government? Above all, it must firmly indicate that it is ready to use fiscal policy as an instrument of counter-cyclical policy to boost demand and growth. However, this ability to put in place significant stimulus packages to revive growth gets constrained when there is no momentum whatsoever on fiscal consolidation. Unfortunately, the government has not been able to utilise the favourable conjuncture of 8.6 per cent growth during the last four years to set its finances in order.

Thanks to its drive to splurge during the last four years — and especially now with a national election only a few months away — the biggest casualty has been fiscal consolidation. The UPA government is living way beyond its means, reflected in high and persistent revenue and fiscal deficits since it came to power. A revenue deficit is incurred when its tax revenues cannot meet expenditures like salaries and other costs of administration. Another word for borrowings is the fiscal deficit.

To be sure, the UPA government announced two stimulus packages on December 2008 and January 2009 to counter the negative fallout of the global slowdown. A stimulus package typically entails higher public investment in building roads, seaports, airports, power and other infrastructure to generate employment and boost aggregate demand. This measure is considered an ideal counter-cyclical measure, rising when the economy is weakening and falling when the economy is strengthening, to revive flagging growth.

The first of these packages, for instance, amounted to Rs 34,000 crore or 0.6 per cent of GDP at market prices and was considered to be insufficient to address the problem of a fast slowing economy whose growth is expected to decline to 7 per cent this financial year and 5 per cent in 2009-10. Five times more than what the government announced would have sufficed to restore India’s growth by one percentage point. While that is the requirement, the fact is that the government does not have the fiscal headroom to meet it.

This space has got narrowed due to big-ticket spending during the last four years. The fiscal deficit of the central government has gone through the roof at 6 per cent of GDP this year, thanks to the waiver of farm loans, a national rural employment guarantee scheme, besides rising food and other subsidies. Adding in the off-budget liabilities on account of oil and fertiliser subsidies plus the borrowings of state governments, takes the combined fiscal deficit of central and state governments to 10 per cent plus of GDP.

For a sense of perspective, this was the level of the deficit when the country went bust in 1991! Such high back-to-1991 deficits pre-empt investible resources and thus prevent the economy from kick-starting growth. Although the latest interim budget urges a substantial increase in expenditure in infrastructural development next year, the point is that this legacy of fiscal profligacy will come in the way of putting together significant fiscal stimulus packages to arrest our faltering growth.

The government has, of course, conveniently used the excuse that extraordinary economic circumstances merit extraordinary measures to set aside adhering to the Fiscal Responsibility and Budget Management Act, 2004, according to which it has to eliminate the revenue deficit by 2008-09 and reduce the fiscal deficit by 0.3 per cent every year. The exigencies of dealing with the global economic turmoil and the compulsions of fighting a national election have put paid to any such responsible behaviour.

The elimination of the revenue deficit, for instance, has been postponed to another year. But there is no way that this can be met even then with this deficit estimated at a whopping 4.4 per cent of GDP this year and 4 per cent of GDP next year.

With such a state of affairs, from where will the internal resources be generated to actively use fiscal policy as an instrument of counter-cyclical policy? Higher deficits crowd out resources that would otherwise have gone to build infrastructure.

The upshot is that dealing with the negative fallout of the global slowdown calls for bold fiscal packages that can trigger much-needed infrastructural investments in ports, power and roads. While that is what is needed, the truth is that the government’s fiscal room for manoeuvre is truly limited due to rising fiscal and revenue deficits. Fiscal consolidation calls for reining in unproductive expenditures, including those on subsidies while broadening the base of taxation. Unfortunately, the interim budget does not provide indications that the UPA will be up to these challenges if it were to come to power again.