Home / Politics / Policy /  Can Budget 2017 provide a push for growth after demonetisation shock?

In his address to the nation on 31 December, Prime Minister Narendra Modi announced a host of schemes aimed at benefitting the not so rich segments of the population. While it is likely that these announcements have been made with the forthcoming assembly elections in mind, the larger question of how the economy would cope with the deflationary impact of demonetisation has been left unaddressed. Given the fact that there is a broad consensus on the fact that the growth rate of the economy would take a hit due to demonetisation, one would have to wait for the budget to see what the government’s strategy is on this front.

How much can the government do in this situation? Not much, unless it decides to abandon its fiscal consolidation map, which was articulated in the Medium Term Expenditure Framework Statement released in August 2016. The statement projected gross fiscal deficit at 3% of GDP (gross domestic product) and a minor decline in Central government expenditure as a share of GDP for FY2018 and FY2019.

The quality of government spending is perhaps as important as its quantum, because a tilt towards capital expenditure sows the seeds of future growth in the economy and has a more positive effect on things like employment generation. On this front too, the picture does not look very bright. The share of capital expenditure in Central government spending has been coming down in the last two decades and although projections for FY2018 and FY2019 predict a departure from this trend, the burden of interest payments and expenditure commitments, vis-à-vis the Seventh Pay Commission and one rank one pension scheme, make one circumspect about whether or not it would happen.

Meanwhile, substantial interest payments, the single largest component of Centre’s expenditure, will continue to remain another impediment towards correcting the imbalance between revenue expenditure and capital expenditure. On the one hand, the government said in its statement released in August that “the growth in interest expenditure is expected to come down" and projected a slight reduction in the interest to net tax revenue ratio owing to lower inflation and interest rate environment and rise in its tax revenues. However, its own projections in the same statement show that interest payments as a proportion of total expenditure are only expected to rise. Moreover, actual tax revenue might lag government’s projections given the likely impact of demonetisation on economic activity, which could endanger the anticipated improvement in the ratio of interest payments to tax revenue.

The numbers presented above show that it would be difficult to expect any significant turnaround in either the quality or quantum of central government spending in the forthcoming budget.

What is remarkable is the fact that there has also been a decline in Central government’s spending on crucial social sectors like health and education under the Modi government. This can be seen from the fact that the share of health and education spending as a percentage of GDP has been coming down since FY14.

To be sure, it could be argued that the given facts do not take into account the changed fiscal arrangement after the recommendations of the Fourteenth Finance Commission (FFC). FFC’s recommendations came into effect from last year and, among other things, entailed a 10 percentage point rise in devolution of tax revenue from the Centre to states, part of which was to be compensated by reduction in funding to centrally sponsored schemes.

How much can states do to provide a fiscal stimulus to the economy? To answer this question one would require a look at the change in state finances in the post-FFC world, and aggregated effect of state government policies. As far as the Union budget is concerned, it could be difficult to strike a balance between considerations of fiscal consolidation and rejuvenating growth.

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