Views | Fiscal-monetary policy mix

Views | Fiscal-monetary policy mix

Last week’s events reflect the overall mix of macroeconomic policies that Indian authorities intend to pursue in 2012-13. Monetary policy remains centered upon inflation, the context of which will guide future easing. Fiscal policy has finally stopped its four-year expansion to refrain from stoking aggregate demand if not as much to consolidate. Monetary-fiscal coordination thus makes a belated attempt to jointly address inflation dogging the Indian economy since 2009.

Fiscal policy has at last changed direction to moderate consumer demand, boost revenue buoyancy, cap subsidies and announce a consolidation path for the next two years even as revenues from proposed asset sales and auctions remain essential to closing the wide fiscal gap of 5.1% of GDP in 2012-13. A 2% hike in excise taxes restores tax rates to the pre-stimulus12%, the service tax base will be widened by the inclusion of all but some services in a negative list (17 exemptions), while some specific taxes are converted to advalorem ones. The government also said that subsides will be capped at 2% of GDP henceforth, thus introducing greater fiscal certainty in a sphere from which has originated all budgetary overshooting in recent times. A new concept, the ’effective revenue deficit’, has been introduced to redirect focus towards capital spending from consumption expenditure, although purists will continue to scan the traditional fiscal indicators. Overall belt-tightening is modest: the fiscal deficit is pegged at 5.1% of GDP in 2012-13, just a tad lower than the much overshot 5.6% of GDP in the year just ended.

Will these measures add to inflation? Indirect tax increases, higher rail fares and power prices will increase prices in a one-off, discrete manner in the near term, as will the upward adjustment of administered fuel prices that were left untouched but are universally expected to be raised soon. Over time though, the reduced surplus with consumers due to higher taxes, lower income growth and moderation in subsidy-grant expenditures will temper growth in consumer spending.

The fiscal impulse, which adjusts the fiscal stance for the economic cycle, is overtly contractionary, says Sonal Varma of Nomura, who estimates a contraction of more than a percentage point. This will impart a negative bias to inflation pressures, create room for monetary easing and crowd-in private investment spending.

If not optimal, fiscal policy is now a realistic second-best that at least makes an effort to join the sole monetary endeavors so far.

Renu Kohli is a New Delhi-based macroeconomist; she is a former staff member of the International Monetary Fund and Reserve Bank of India.