Fiscal flexibility: Will a global rethink favour India?

The government recently appointed a committee to review the working of the Fiscal Responsibility and Budget Management Act. The committee will also examine if a ‘range’ instead of a ‘point’ deficit target is viable. A fiscal deficit range would give the government some flexibility to ‘deal with dynamic situations’ such as unanticipated shocks to aggregate demand or supply. Presently, the budget specifies a fixed fiscal deficit which shapes market expectations—the quantum of government borrowings from the market affects bond yields while issues related to fiscal discipline are a major source of uncertainty.

The ‘range’ versus ‘point’ issue has made news for some time. Recent reports (See: Govt may Open Its Spending Tap to Nurture Green Shoots, The Economic Times, 21 May ) say that the government is exploring ways to escalate spending to encourage private investment and boost growth to 8% in 2016-17. To be sure, public capital spending was raised marginally to 10.4 and 10% of gross domestic product (GDP) in 2014-15 and 2015-16, respectively, from 9.9% in 2013-14 and so far has failed to spur business spending.

This is possibly forcing policymakers to focus on magnitudes. A bit of flexibility would help expand capital spending. Against the background of news reports, it would not be a surprise if the committee finds merit in a ‘band’ than a fixed target. What the attendant rules or conditions could be though is worth pondering over, considering the country’s official growth rate in recent years.

The desire for fiscal flexibility also comes at a time of global rethinking on the merits of fiscal rectitude. The International Monetary Fund, perhaps the sternest agency on fiscal matters, recently asked if the benefits of fiscal austerity have been overplayed ( See: Neoliberalism: Oversold? by Jonathan D. Ostry, Prakash Loungani, and Davide Furceri, Finance & Development, June 2016). Constraints to government spending through limits on the size of fiscal deficits and on the ability of governments to accumulate debt can actually be growth-negative by hurting demand and worsening employment-unemployment outcomes, instead of raising private sector confidence and investment, says the article. This holds especially for countries with a track record of fiscal responsibility (think of Germany, UK and the US).

We do not yet know if, and how, a changing mindset overseas will influence the fresh consideration of fiscal bounds—the pace of consolidation and other related issues here in India. International cover, i.e. a shift towards fiscal accommodation driven by recognition of a secular decline and structural changes in demand in the major advanced economies, may help advance the case for higher government spending, or fiscal policy reset at this point.

However, India’s fiscal history does suggest that the country’s track record may matter for market confidence, while the buoyant GDP growth numbers might restrict the cause for higher government spending.

Renu Kohli is a New Delhi based economist.