The US has shutdown, should India too?

A US-style shutdown for one month could trim India's deficit by a third, according to an India Spend study

Finance Minister P Chidambaram has reiterated not once, but over and over again, that India will not breach the red line on its fiscal deficit number. The data for the first five months isn’t looking pretty though. The April to August figure has crossed 75% of the annual target, leaving many to wonder whether the finance minister would indeed be able to stick to the 4.8% target.

In the same five-month period last year, the number was 65.7%, but Chidambaram walked the talk, reining in the fiscal deficit at 5.3%. This time though, the amount we’ve exhausted in the first five months is 10% higher. Also, it is a pre-election year, GDP growth has been revised further downward, which means revenues going ahead are likely to go out of whack even as expenditure remains sticky, and the country is still battling a volatile currency. To top this, there hasn’t been significant progress on fuel subsidy reform (notwithstanding Veerappa Moily’s Rs 40,000 saving after he took the metro to work yesterday) and the tab on entitlement programmes like the food subsidy bill is only going be steeper. Ratings agencies are clearly unimpressed with India’s pace of expenditure trimming, so the threat of a downgrade looms.

How, pray, does one solve this predicament?

Well if you are looking for an out of the box solution, we could borrow a leaf from the US’s book and shut down the country for some time.

Shut down the country?!

Well, a study by Manika Premsingh, an economist and founder of Orbis Economics, for www.indiaspend.com suggests that a 30-day shutdown in India will reduce government expenditure by 10% and reduce the fiscal deficit by a whopping 31%!

Of course, this is not a real practicable solution. But for the sake of argument, Premsingh’s study measured what impact a per day government shutdown would have on a proportionate cutback in overall annual expenditure and thus the fiscal deficit. The results point toward a rough 1:1 ratio for the deficit – i.e. a one-day shutdown would reduce the fiscal deficit by 1%, a six-day shutdown by 6.2% and so on. The calculations, like in the US, consider that expenditure on essential services like defence, social security etc will continue. But discretionary spend on items like public sector salaries, presumably museums, parks etc would be cut back.

A reduction in the fiscal deficit will come at the cost of growth though.

“There would be a second round impact of a shutdown. This is because limited government expenditure impacts earnings of the individuals employed by the government. This, in turn, will potentially impact the demand for goods and services in the economy in a negative way as well and thus depress overall GDP growth,” writes Premsingh.

The US GDP is expected to decline by 0.3% with every week of a shutdown. A further growth crash is the last thing India needs at a time when the IMF has already slashed its GDP forecast at market prices to an abysmal 3.75%.

That’s not to say though that it is an either or (fiscal deficit vs growth) choice for India. For us reducing the fiscal deficit is an imperative while charting the growth path. While developing countries usually run high deficits, it is to finance investment expenditure on things like building infrastructure etc. In India’s case while gross capital formation has remained stagnant, the structural deficit (on account of enhanced subsidies) has bloated, leading to a chronic situation of high interest rates, high inflation and thus slow growth.

So maybe not a shutdown of the country, but axing of subsidised fuel for a month, as a one-time measure? That calculation could be interesting and pragmatic.