Fiscal Consolidation and Fiscal Deficit

• Budget for 2016-17 has stick to the road map for fiscal consolidation by fixing the fiscal deficit at 3.5 per cent of the gross domestic product (GDP).
• This sends out a clear message that the goal of the government is to accelerate growth under conditions of macroeconomic stability.
• However, in this context, two different questions arise. One is about the credibility of this commitment and the other, a more fundamental one, is whether it is necessary at all to adhere to a fixed road map.
• Under the Fiscal Responsibility and Budget Management Act, 2003, the mandated target for the Central government is 3 per cent of GDP. so far the government has not taken a ‘rigid’ position on fiscal deficit. The fiscal deficit for 2015-16 is almost 1 per cent above the mandated level.

Analysis:

• It is the need of hour to contain fiscal deficit. It is important to note that sustained high fiscal deficits not only lead to a rise in the debt-GDP ratio but also to an increase in interest payments as a proportion of revenues, leaving less for productive expenditure. As a percentage of net tax revenues to the Centre, interest payments have jumped from 38.9 per cent in 2007-08 to 46.7 per cent in recent years. For 2016-17, the Budget retains it at the same level. It is a good sign that the ratio remains the same despite the revenue base coming down because of increased devolution to States. Without a conscious effort to contain fiscal deficit, this ratio will only keep rising.
• There is logic of correlation between credit expansion and fiscal deficit which has five sequential limbs: One, money is the blood of economic growth. Two, most money that fuels the economy is created by banks, not by government. Three, banks and financial institutions fund business and others, and it is that credit money which drives the economy. Four, if, for whatever reason including lack of business confidence, the bank credit to the economy does not adequately grow, like it did not in the last few years, economic growth will suffer for want of adequate money. Five, that is when the Budget needs to step in, to pump money into the economy by incurring deficit (spending more than the income), and, for the purpose, borrow the money lying with banks or even by printing more money, if that is needed.
• The money may lie idle in banks, and yet the law will not allow the government to borrow! This is perverse economics. The economists world over unanimously agrees that as money is critical for economic growth, without adequate money, GDP growth will suffer.
• If bank credit growth falls, fiscal deficit may need to go up. If bank credit growth rises, fiscal deficit should reduce. This is particularly true for a growing economy like India. Had the fiscal deficit not been above the FRBM ideal limit of 3 per cent in the last four years, the growth would have suffered even more. It does not need a seer to say that the FRBM law as its stand harms the economy. The Finance Minister has rightly decided to get it reviewed.
• This would give the necessary policy space to deal with dynamic and volatile situations such as the one India currently faces — global economic and financial market uncertainty, a slowdown in China, and tepid private investment demand domestically.And the Government need to ensure that any resources freed up from a fiscal reset, when that happens, are spent imaginatively for an economic stimulus, and primarily on the creation of long-term public assets.
• The decision to stick to the path of fiscal consolidation is a wise one. It will send out the right signals to the investors. The impact of high public spending will depend upon the drive and efficiency with which the new projects and programmes are taken up and executed. Implementation is the key to boosting investor confidence.

By: Vishal