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[op-ed snap] Wrong time for fiscal squeeze

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Mains Paper 3: Economy | Indian Economy Issues relating to planning

From UPSC perspective, the following things are important:

Prelims level: Basic terms related to fiscal consolidation like fiscal deficit, etc.

Mains level: The article comprehensively deals with the issue of Fiscal Consolidation, government borrowings and its effects on the Indian Economy. It is an important issue as the government has recently decided to borrow more before the annual budget, Govt. to borrow more; fiscal deficit may widen.


News

Current issues with the Indian Economy

  1. There is a distinct slowdown in economic growth
  2. Employment creation, already too little, has slowed down even more
  3. The persistent recession and fragile recovery in the world economy, means that external markets cannot provide the demand to stimulate growth
  4. Is anything positive: The good news is that inflation is moderate and world oil prices are still low
  5. Yet, the economy remains vulnerable to shocks such as a jump in oil prices or a bad monsoon

Issue of Fiscal Deficit(in this fiscal year)

  1. There are revenue shortfalls attributable to the complex structure and hasty implementation of the goods and services tax (GST)
  2. There are expenditure overruns
  3. It is possible that the forthcoming budget resorts to an adjustment of revised estimate (revenue and expenditure) so that the fiscal deficit conforms as closely as possible to what was targeted
  4. For avoiding dampening of the GDP further, the government has no choice other than to allow fiscal deficit to exceed the target

Two opposite views on ‘what should be done’

  1. (1) At one end, there are those who want a reduction in the fiscal deficit in conformity with the targets: 3.2% of GDP in FY18 and 3% of GDP in FY19
  2. They have an ideological belief in the virtues of fiscal consolidation
  3. (2) At the other end, there are those who want fiscal expansion to boost growth in the economy through domestic demand in the face of a global slowdown
  4. They hope that government expenditure on consumption and investment will stimulate demand to revive economic activity
  5. But if the object is to drive economic growth and foster employment creation, the choice is obvious(i.e. to follow 2)
  6. In an economic downturn, fiscal policy must be expansionary

Why are investment and exports important determinants of economic growth?

  1. From demand side: The three sources of growth on the demand side are consumption, investment and exports
  2. Investment, which is decided upon within the economy
  3. And exports, which depend on world demand for our goods, are the primary, autonomous sources of demand that drive growth in output
  4. From supply side: Investment and exports are also critical determinants of growth from the supply side
  5. Investment creates capacities or raises productivity, both of which increase output from the supply side
  6. Exports, which must be price- and quality-competitive in world markets, raise efficiency and productivity of exporting firms to drive growth in output

Issues with the monetary policy

  1. Monetary policy should provide stimulus to private investment by lowering interest rates
  2. The Reserve Bank of India stubbornly resists, refusing to recognize that it was the low oil prices rather than high interest rates that tamed inflation
  3. Instead, it caught in the flawed belief system that inflation can be controlled by high interest rates

Are the government borrowings reliable?

  1. Government borrowing is always sustainable if it is used to finance investment and if the rate of return on such investment is greater than the interest rate payable
  2. Hence, there is nothing sacrosanct about keeping the fiscal deficit at 3% of GDP

Primary deficit and the Fiscal Situation

  1. The primary deficit, which is the gross fiscal deficit minus interest payments, reflects whether the fiscal situation is getting better or worse, is estimated at a negligible 0.1% of GDP in 2017-18
  2. These numbers suggest that the fiscal situation is not a cause for concern

The way forward

  1. Government deficits are better managed by increasing revenues for which there is ample scope just by improving tax compliance
  2. Our direct tax rates are among the lowest in world. So are direct tax-GDP ratios
  3. It is time to remove exemptions and deductions
  4. GST is a step in the right direction for indirect taxes
  5. But it is essential to reduce its multiplicity of rates and complexity in administration
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