Why Jaitley should steer clear of the easy attractions of fiscal profligacy
Prudence demands that the FM keep some fiscal gunpowder dry in case there is a global shock during the rest of this year. Global oil prices have been climbing ominously.editorials Updated: Jan 31, 2018 19:24 IST
The first instinct of any rational politician is to open the spending spigots in the months leading to an important election. Finance minister Arun Jaitley will today present the fifth budget of the Narendra Modi government, and the last before the next general elections. The bond market has had a jittery couple of weeks because of fears that the finance minister of an election-bound government will stray from the fiscal trajectory he has promised to maintain.
There are two key reasons why Mr Jaitley should steer clear of the easy attractions of fiscal profligacy. First, the Indian economy is rapidly recovering from the twin shocks of demonetisation as well as the transition to the goods and services tax (GST). Inflation is also rising in tandem. It does not make sense to meaningfully increase the fiscal deficit when the private sector’s demand and exports are bouncing back.
Second, prudence demands that the FM keep some fiscal gunpowder dry in case there is a global shock during the rest of this year. Global oil prices have been climbing ominously. Economists estimate the Indian current account deficit will widen to a five-year high of around $70 billion in the next financial year. At the same time, the international capital available to fund this deficit is expected to shrink as the US reverses quantitative easing by reducing the size of its central bank balance sheet as well as raising interest rates.
The domestic economic recovery that is gathering momentum could thus be halted in its tracks in case there is a global shock later in the year. That is when the government may need fiscal firepower – aka spending capacity – to keep the Indian economy on track. A profligate budget right now will not just limit the space to deal with economic turbulence closer to the next election but also push up domestic interest rates.
Does that mean there is nothing to be done to deal with pressing problems such as rural distress, infrastructure shortages and providing fresh capital to banks? Higher tax collections from faster economic growth, the end of the initial teething problems for GST, the sharp increase in enterprises paying tax and aggressive privatisation should lead to revenue buoyancy. Any decision on the reintroduction of a tax on capital gains for assets held for more than a year should also be seen in this context.
The political challenge will be to use higher revenues to relieve rural distress, build physical capital and nurture human capital, rather than fritter it away on subsidies. How these allocations are decided will critically depend on the political risk appetite of the PM.