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Turn of the stimulus tide

Turn of the stimulus tide
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First Published: Thu, Jun 10 2010. 08 34 PM IST

Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint
Updated: Thu, Jun 10 2010. 08 34 PM IST
It is now well known that the biggest threat to the global economic recovery is the fiscal mess in developed countries. This newspaper has been arguing in these columns for more than a year that the unprecedented fiscal expansion we saw since September 2008 saved the global economy from utter collapse, but did little to deal with the underlying fault lines.
The Keynesian tide is now turning. The finance ministers and central bankers from the Group of Twenty (G-20) countries, who met in the South Korean city of Busan this month, said in no uncertain terms in their joint statement that “countries with serious fiscal challenges need to accelerate the pace of consolidation”. This is in sharp contrast to the tone of the April statement, where governments were urged to keep the spending taps open.
Illustration: Jayachandran/Mint
European leaders have already announced fiscal austerity plans in the wake of crumbling market confidence in their economies. The new British Prime Minister, David Cameron, has not pulled any punches in statements that have warned the public that they would have to get used to years of pain as government spending is cut. The Obama administration is more circumspect, even though there is growing evidence that the US is stumbling into a deep debt-and-deficit hole.
Critics of immediate fiscal consolidation have a strong case when they say that lower spending or higher taxes at this juncture will shatter the fragile global economic recovery. But they fail to take on board the fact that the downturn is not the result of a shortage of effective demand, but the aftermath of a burst asset bubble. Western nations and citizens do not need to spend more. Their main task right now should be to reduce debt and increase savings. Free spending policies at this juncture will merely convert a cyclical deficit into a structural one.
India, too, needs to get its public finances in order soon, especially when the current account deficit is growing rapidly and global capital flows are expected to be volatile. The 3G (third-generation) bonanza will allow the government to meet its budgeted fiscal deficit target, but such one-time windfalls merely paper over deeper imbalances in public finances, especially high primary and revenue deficits. That said, the smart recovery in Indian growth should help fiscal consolidation.
There is another potential worry for India. Tighter fiscal policy in the West would need to be balanced by an even more loose monetary policy, thus sending gushes of liquidity towards the emerging markets. The Reserve Bank of India may need to be vigilant about an appreciating currency and a growing asset bubble later this year.
Is this the time for austerity? Tell us at views@livemint.com
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First Published: Thu, Jun 10 2010. 08 34 PM IST