Quality of fiscal adjustment key to recovery

RBI'S MACROECONOMIC AND MONETARY DEVELOPMENT REPORT

Growth in total expenditure decelerates, led by lower growth of revenue expenditure.

The Reserve Bank of India, in its annual report on macroeconomic and monetary developments in 2009-10, has advocated greater emphasis on quality of fiscal adjustment. Fiscal adjustment refers to management of government finances in a way that the gap between revenue and expenditure is minimised.

Supporting the efforts of the government towards this, RBI stated that during 2009-10, even though the expansionary fiscal policy of the central government continued, growth in total expenditure decelerated substantially, led by significant reduction in growth of revenue expenditure.

In order to avoid the contagion effect of the global financial crisis on the Indian economy, the government doled out a large fiscal stimulus as a response to an exceptional circumstance. "But by nature, these measures had to be temporary and rolled back over time to ensure sound fiscal position as a means to sustainable high growth in the medium term," the report stated.

The budgeted plans for 2010-11, recognising the significance of fiscal discipline for medium-term growth and inflation outlook, and also taking into account the clearer signs of recovery in GDP growth, pointed to the beginning of exit of fiscal stimulus measures in a calibrated manner, the report stated. Thus, the total expenditure was slated to increase at a substantially lower rate than in the previous two years.

"However, growth in capital expenditure, which was raised significantly in 2009-10 has further been revised upwards in 2010-11. This could be expected to aid medium-term growth prospects, despite overall moderation in the growth of government expenditure," the report added, while reflecting on the fiscal management of the government to trim expenditure without sacrificing its focus on growth.

As a concern, the report highlighted that the expected increase in prices of manufactured goods following this rollback in indirect taxes may entail some dampening effects on private sector aggregate demand. Along with the impact of decelerated government expenditure, the support from fiscal policy related measures to aggregate demand, thus, could be much less than in the preceding two years, it stated.

On the other hand, direct tax measures, such as increase in income tax slabs, would increase the private disposable income by about 0.4 per cent of GDP. This would have some positive impact on aggregate demand. "The concessional customs duty, exemption of excise duty and service tax announced in the Budget on a number of items such as select agricultural goods and related sectors, environment-friendly products, monorail projects for urban transport, domestic manufacture of mobile phones and medical equipment will have some positive impact on the private sector aggregate demand, while providing incentive to expand output of these goods," the report said.

Further, to boost domestic aggregate demand, states were encouraged to raise additional market borrowings. "An additional factor that influenced state finances during 2009-10, but with positive implications for aggregate demand, is the implementation of the Sixth Central Pay Commission/State Pay Commission recommendations," the report said.

It concluded that state and government expenditure combined decelerated sharply due to containment of revenue expenditure in 2009-10. This, in turn, weakened the direct contribution of government expenditure to growth in aggregate demand, it said.