The government has passed the halfway mark on the deficit target in the first four months of the fiscal and there have been no visible attempt made to contain expenditure. Increasingly, it looks certain that the government will miss the target of restricting fiscal deficit to 5.1% of gross domestic product by a significant margin. In itself, this will not be unusual; after all, this target was missed last year, too. In the given context, however, it spells bad news for it sends no positive signal to the Reserve Bank of India to reduce policy rates. The central bank has already said that unless there are credible fiscal consolidation efforts, it will be difficult for it to reduce interest rates.
Although some noise about consolidation has been heard from the North Block, especially after P. Chidambaram took over as finance minister, but the intent is yet to be translated into action. And action on this front will be difficult, both economically and politically. With the passage of time, adjustments will only be more painful, especially at a time when the economy is decelerating faster than expected. In the current state of the economy, both ways of balancing the budget—raising taxes or cutting expenditure—will have different sets of damaging consequences. In sum, these will further pull down the growth momentum. On the one hand, if the government raises tax rates—a distinct possibility—it will affect demand, savings and investments and have a medium- to long-term impact on growth. On the other hand, cutting expenditure—a difficult political option—will again have different set of implications depending on areas where the cuts are inflicted.
However, not taking a decision even at this stage is possibly not an option, as the country runs a big risk of losing investment grade status in the international market as a result of a credit rating downgrade. A downgrade will not only bring in serious financial hardship for the companies borrowing from the overseas market, but will also impact capital flows directly affecting the external accounts and the value of rupee. There is now a risk where an out-of-hand fiscal deficit quickly translates into a balance of payment and a currency crisis. Therefore, it is important that the issue is addressed quickly and, as argued earlier in this space, addressing subsides like the one on diesel is a good starting point.
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