BackThe case against a fiscal stimulus
The choice before India is between economic growth and fiscal profligacy
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Does India need a fiscal stimulus right now? In the week that the first full budget of the National Democratic Alliance government is due to be announced, there are two reasons why this newspaper disagrees with economists who have been quite persuasively arguing for higher public spending.
First, India already has one of the highest fiscal deficits as a percentage of gross domestic product (GDP). A look at the global numbers published by the International Monetary Fund in the October edition of its Fiscal Monitor is instructive. India is clearly an outlier when it comes to the size of its consolidated fiscal gap, or even the standalone deficit of the central government.
Much depends on the state of the economy. Yet, even the cyclically adjusted fiscal deficit—which takes into account potential GDP—is among the highest in the world. Greece has better budget numbers. Japan is the only major economy which has a fiscal deficit that matches the one India has, and that is after more than two decades of economic stagnation.
It is true that fiscal profligacy has not led to a sharp increase in public debt as a percentage of nominal GDP, which is the true indication of the quality of public finances in the long run. But that is because public debt has been inflated during the recent episodes of rapid price increases. Negative real interest rates have also helped keep public debt sustainable. The strategy cannot work now as disinflation is bringing down the rate of nominal GDP growth.
Second, the call for fiscal expansion does not fit well into the larger narrative of an economic recovery. A fiscal stimulus works with a lag of around three or four quarters, so an expansion in the budget deficit after April will stimulate economic activity only around the end of the next fiscal year or the beginning of 2016-17. The Indian economy could perhaps be growing close to its potential by then.
The negative output gap will be minimal, so it is quite likely that the effect of a fiscal stimulus will be inflationary. The new estimates of GDP growth are suspect in many eyes but even the earlier numbers suggested that India would grow at around 7% a year by 2016-17, or around its potential growth rate.
There is scarcely a country right now that is trying to increase its fiscal deficit. That India should try to do so just at the moment when it seems to be emerging as the fastest-growing major economy in the world defies logic. Either India doesn’t need a fiscal stimulus or the claims of being the new star of the global economy are hollow. The government has to decide which narrative it is going to embrace.
There remains the issue of public investment. There is no doubt that the ongoing economic recovery will falter unless investment activity picks up. The private sector is too busy dealing with financial stress to think about new projects, especially in the key infrastructure sectors. The shadow of regulatory risks is also a long one.
There is a compelling economic case for higher public investment till private investment picks up. The latest Crisil survey released on Tuesday buttresses this claim. The survey found that of 192 listed companies (both public and private sector)—drawn from key sectors such as infrastructure and energy—showed a 4% decline in capex plans for 2015-16. Worse still, it found an 11% year-on-year decline in the capex plans of private-sector companies polled.
But any increase in pubic investment needs to be done while maintaining fiscal discipline, perhaps by using the savings from lower global oil prices to fund new infrastructure projects.
There will be greater clarity on these issues when finance minister Arun Jaitley announces the new government budget on Saturday. He has repeatedly said he will stick to the fiscal deficit target that he had committed himself to in the July budget.
He will also have to throw light on the plan for fiscal consolidation over the next few years. And—this could be his main challenge—he will have to act like a fiscal conservative while Prime Minister Narendra Modi often speaks of a China-style infrastructure push when investment sentiment is weak in the private sector.
How this paradox will be tackled is perhaps one of the biggest policy challenges of the government.
Should the finance minister revert to the path of fiscal conservatism? Tell us at views@livemint
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