Government Budgets

The reason that India cannot afford to go on a debt binge

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Fiscal deficit

Mains level : Paper 2- Challenges posed by high debt levels

The article discusses the challenges associated with the Budget with a high fiscal deficit.

Change in government’s stance

  • India’s economy has suffered more than most from the covid pandemic and so have its people.
  • Its economic contraction has put pressure on its government, like so many others, to respond.
  • Until this week, government’s response had been relatively restrained.
  • The government implied that any welfare-promoting and growth-enhancing measures had to stand on a solid macro-economic foundation.
  • The federal budget for the next financial year, 2021-22, with the fiscal deficit for the current fiscal at 9.5% of gross domestic product (GDP) has changed that optimistic narrative.
  • The government has effectively abandoned its long-term commitment to bring the deficit down to close to 3% of GDP, pitching instead for a gentle descent to 4.5%—six years from now.

Implications of high fiscal deficit

  • Once the covid pandemic retreats, India might end up with a debt-to-GDP ratio of about 90%, compared to the low 70s at present.
  • It would be saddled with a permanently elevated fiscal deficit and a financial system bogged down by high levels of bad debt.
  • Consumer price inflation has topped the Reserve Bank of India’s target zone of 2%-6% since the covid lockdown began last year.
  • Unlike the US or China, countries in India’s position—which have neither a reserve currency nor strong growth momentum—cannot grow rapidly while exploding their debt.
  • They can’t afford to ignore rating agencies because of their supposed bias, or cock a snook at bond markets and just run the currency presses instead.
  • They need to grow in order to reduce their debt. That’s a very different dynamic.
  • India isn’t so attractive that it can expect vast sums of investment to arrive even if its macro-economic numbers look bad and its sovereign rating is junk.
  • We don’t have a history of deflation, we aren’t hitting the zero lower bound.
  • It’s quite the opposite; we have an economy prone to sustained high inflation.
  • India is not in a position in which it could build really productive assets using sustained deficit.
  • This is still a developing economy, which especially in bad times should tread carefully rather than throw caution to the winds.

Rationale behind high spending

  • The government is hoping that increased spending will help India grow out of this predicament.
  • The only way India can pull itself out of this jam is if private investment pours into the country, financing projects that push up the country’s potential growth rate.
  • Yet the government, already monopolizing domestic financial savings, seems to want to go to war with global markets as well.

Consider the question “Fiscal deficit figures for FY21 marks the end of India’s departure from the path of fiscal consolidation. Discuss the challenges posed by such high fiscal deficit to the Indian economy.

Conclusion

India’s greatest strength had been his commitment to fiscal responsibility. The path of fiscal adventurism could end up leaving India’s macroeconomy vulnerable.

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