Background:
The government of India is working on a plan to revive the economy after growth slipped to a modest rate of 5.7% in the first quarter of the current fiscal compared with 7.9% in the same quarter last year.
Media reports suggest that it is mulling a fiscal stimulus to boost growth, which could increase the fiscal deficit.
The idea is that in the absence of sufficient investment demand from the private sector, higher government expenditure will help boost gross domestic product (GDP) growth.
Providing fiscal stimulus- Not a good option:
There are sound economic reasons why the government should adhere to its fiscal commitments.
The deceleration in growth is partly being explained by the lingering impact of demonetisation and destocking before the implementation of the goods and services tax (GST).
The impact will peter out and output affected by these events doesn’t need fiscal support.
Opening the fiscal tap at the moment would mean that crucial reforms in areas such as improving the ease of doing business might get postponed.There is no guarantee that expanding the deficit will take India to a higher sustainable growth path. In fact, the economy already has a fair amount of fiscal support with the combined fiscal deficit running in excess of 6% of GDP.
Expanding the deficit by another half a percentage point, for instance, is unlikely to change things materially on the ground.
Furthermore, the government has exhausted over 90% of the estimated fiscal deficit for the year in the first four months, but it has not resulted in the desired level of growth.
All this shows that increasing government spending may not be sufficient to boost growth in a sustainable manner.Expanding the deficit can complicate policy choices for the Reserve Bank of India (RBI).
It can affect RBI’s target of keeping inflation around 4% on a durable basis.If the government decides to expand the deficit in the current year, a reversal will be unlikely in the next fiscal, as it will end close to the general election. This means that the deficit will remain elevated for a considerable period and would affect investor sentiment.
It is in India’s own interest to keep its house in order and minimize risk from external shocks.
Interventions that go beyond stimulus are required:
Economic growth has slowed considerably and the economy needs policy intervention that goes beyond running a bigger deficit.
What the economy needs is deeper and broader structural reforms that will help attain sustainable higher growth in the medium to long run.
Proper implementation of big-ticket reforms like GST and the bankruptcy code.Factor markets such as for land and labour, and public sector banks need immediate attention.On the fiscal front, government should address all the issues in the functioning of GST. If revenue gets affected because of operational issues, fiscal management will become extremely difficult. Higher tax revenue from GST will help push public expenditure.The government should also aggressively pursue disinvestment and privatization, which will help augment resources.
Conclusion:
Irrespective of the slowdown, the Indian economy needs higher public investment, but it need not come at the cost of fiscal discipline.