When fiscal deficit is so high, stimulus measures must be carefully calibrated for effectiveness
Business Standard / New Delhi Feb 26, 2009, 00:36 IST
The fiscal stimulus announced by the government on Tuesday will make many businesses happy. The resultant price cuts that have been announced could well encourage some revival of demand—which was the intended effect. Given the Constitutional constraints on the government, such indirect tax changes were the only option left as far as conventional fiscal instruments were concerned. There were significant expectations that these or similar measures would be announced in the Interim Budget presented last week, but the government argued at the time that propriety came in the way of any fresh stimulus package—an explanation that begs the question as to when such propriety issues got time-barred. If the real explanation is that the government did not think last week that a fresh stimulus was required, and changed its mind after the howl of protest that greeted the Interim Budget’s inaction, it creates the impression that North Block is not applying a firm hand to the rudder, and is reacting to criticism rather than working to its own plan.
It may be a contradiction to speak of fiscal stimulus and fiscal discipline in the same breath, but the fact is that there are more efficient and less efficient ways of providing a fiscal stimulus. In the current scenario, in which the effective fiscal deficit is already at record levels, there has to be very careful calibration of further stimulus measures, for effectiveness and appropriateness. When the Interim Budget was presented, there was some uncertainty about whether the reductions announced in December, which were supposed to expire on March 31, were to be extended or not. That they will be extended was made clear only in Tuesday’s announcement. Those reductions were estimated to cost about Rs 8,700 crore in lost revenue over four months; extrapolated for a full year, that would translate into almost Rs 25,000 crore. Add to this the Rs 29,000 crore foregone by the further cuts on Tuesday and the result is an immediate addition of Rs 54,000 crore to the estimated deficit for 2009-10. That is over and above the Interim Budget estimate, and would take the deficit for the next financial year to 6.4 per cent of GDP. If, in addition, the new government pushes through with another 1 per cent of GDP as Plan spending, as has been indicated, the deficit would climb to 7.4 per cent of GDP—nearly the same level as this year, despite not having to pay for a farm loan waiver and bloated oil and fertiliser bills.
This is a huge burden. Under the pressure of government borrowing to finance the deficit, interest rates will harden—and almost certainly crowd out private borrowers. This can be avoided only if the Reserve Bank of India buys back the monetary stabilisation securities so as to pump out more cash, and drops the cash reserve ratio so that banks have money to buy government bonds. But that will not address the growing international worry about the fiscal direction in which India is headed. One rating agency has put India on rating watch, and the eventual loss of investment grade rating should not be a surprise. There is the risk of tax revenues falling short of estimates, of global funds steering clear of India for fear of the downside risk, and as a consequence failure to get various infrastructure projects off the ground (because domestic funding is too small to fit the bill).
Strangely enough, its not just the India's finance which is heading in the wrong direction but also its democracy.
Fiscal deficit is not an issue, as if no one in India cares about how their children will live. Political parties are pandering to different groups, like judges and civil servants by increasing salaries without any increase in accountability/efficiency.
With this democracy and deficit, hope will be in short supply.
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