×
Home Companies Industry Politics Money Opinion LoungeMultimedia Science Education Sports TechnologyConsumerSpecialsMint on Sunday
×

Fiscal policy: what UPA ought to do

Fiscal policy: what UPA ought to do
Comment E-mail Print Share
First Published: Sat, May 16 2009. 11 50 PM IST

Sonal Varma. India economist, Nomura Financial Advisory & Securities
Sonal Varma. India economist, Nomura Financial Advisory & Securities
Updated: Sat, May 16 2009. 11 50 PM IST
The incoming United Progressive Alliance (UPA) government faces a very delicate balancing act: On the one hand, it needs to provide more fiscal stimulus to support the economy, and on the other, it must ensure that its finances do not spiral out of control. The fiscal strategy can be formulated by focusing on three time horizons: near-term, medium-term and long-term.
Sonal Varma. India economist, Nomura Financial Advisory & Securities
The immediate focus will be to reactivate fiscal policy after the deep freeze since late February. The final budget has to be presented in July and could extend some fiscal concessions, including increasing Plan expenditure to boost domestic demand.
Since the government’s large market borrowings are already putting upward pressure on sovereign bond yields, an alternative source of financing the fiscal deficit is required. The Reserve Bank of India (RBI) is partly accommodating the excess borrowing by buying back government bonds, but disinvestment is also an option that can help reduce the overall burden on the market.
Given the limited fiscal leeway, prioritizing spending is essential. Only measures that are most effective in terms of their multiplier effect and which are required in the long run, such as spending on infrastructure and employment generation activities, should be announced.
More importantly, any near-term fiscal announcement has to clearly communicate the road map for medium-term fiscal consolidation. Or else it can lead to rising long-term yields, sovereign credit rating downgrades, a loss of foreign investor confidence and capital outflows.
As the economy recovers, the medium-term strategy will be getting fiscal finances in order. While crowding out of private investments is not a threat currently because of slack investment demand, it can become a potent threat once investments start to recover. Therefore, the government will have to be ready to withdraw its fiscal stimulus as recovery becomes imminent. Tough decisions such as raising taxes and reining in spending will be required.
During this time, the coordination between fiscal and monetary policy will be critical to unwinding the large expansionary policies implemented during the crisis. If the fiscal deficit continues to be high, then it can counter any steps taken by RBI to tighten liquidity and risks fuelling inflationary expectations. On the other hand, if fiscal consolidation needs to be accelerated, monetary policy may need to be looser than otherwise.
The long-term fiscal strategy road map is fairly clear. A new framework of counter-cyclical fiscal rules is required to succeed the existing Fiscal Responsibility and Budget Management Act. The off-budget fiscal items have to be brought above the line.
Moving away from administered pricing is also needed to reduce the vulnerability of public finances to commodity price shocks. An integrated national goods and services tax also remains on the anvil.
Ultimately, the growth path that the country takes over the next few years will depend crucially on the UPA government’s fiscal strategy.
The last thing that India needs is a repeat of the fiscal situation from 1998-2002 when a combination of weak growth and the Fifth Pay Commission wage hikes caused government finances to deteriorate sharply. The combined fiscal deficit stayed above 9.0% of the gross domestic product over these five years and investments remained weak. The situation today is alarmingly similar.
The UPA government has the advantage of continuity in policy, a decisive mandate and the understanding of the challenges at hand. It should not allow a repeat of the fiscal deterioration, or the economy could take much longer to return to its full growth potential.
Respond to this column at feedback@livemint.com
Comment E-mail Print Share
First Published: Sat, May 16 2009. 11 50 PM IST