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Why we need fiscal fitness

Why we need fiscal fitness
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First Published: Thu, Feb 04 2010. 09 43 PM IST

 Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Thu, Feb 04 2010. 09 43 PM IST
The magnificent Indian economic boom after 2003 was neither a flash in the pan nor based on a mountain of foreign debt. Underlying the acceleration in growth rates was a secular rise in rates of domestic savings and investments.
Illustration: Jayachandran / Mint
The government last week released a new set of national accounts for which the base year was shifted from 1999-2000 to 2004-05. One troubling revelation was that the domestic savings rate dropped by 3.9 percentage points and the domestic investment rate was down 2.8 percentage points in fiscal year 2009 compared with their levels a year ago.
Basic economic theory tells us that if productivity and labour participation ratios stay constant, a fall in investment rate will translate into a drop in the sustainable growth rate of economic output.
Finance minister Pranab Mukherjee should be taking a close look at these numbers as he puts the final touches to the new Union Budget. The reason is simple enough. A major part of the decline in the national savings rate can be explained by the fall in government savings as a result of the huge rise in deficits over the past 18 months.
That’s one huge reason why the finance minister should announce a credible road map to set public finances in order, which the 13th Finance Commission has already done in a report which has not been made public as yet.
The short-term risks from a yawning fiscal deficit are well known: higher interest rates, once corporate demand for funds picks up, and the danger that credit rating agencies could downgrade Indian debt in case the deficits persist at close to current levels.
The new data on savings and investment also suggest a longer term risk from persistently high deficits: lower rates of investment and growth.
A convenient way to dismiss these fears is to argue that the rise in the fiscal deficit is merely a result of the stimulus the government was forced to give the economy in the midst of a violent global downturn. The deficit will automatically shrink once the economy recovers and tax collections pick up. So why bother too much about a cyclical deficit?
But that is not the entire story. One part of the problem is structural: a rise in spending on politically attractive welfare programmes, a higher wage bill and interest costs on public debt.
India needs a credible fiscal correction before structurally high deficits put the long-term growth story at risk.
How soon will the savings rate bounce back? Tell us at views@livemint.com
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First Published: Thu, Feb 04 2010. 09 43 PM IST