'Deficits hampering growth'

The increasing fiscal deficit in India will have an adverse impact on the rate of capital formation and growth.

The major problems facing the Indian economy are the large budget deficit and the resulting high level of national debt.

"If India did not have its current central government deficit of around 6 per cent of GDP, the gross rate of capital formation could rise from 24 per cent of GDP to 30 per cent. The net rate of investment would rise more. Over the next decade, this enhanced rate of net capital accumulation would have been enough to add nearly a full percentage point to the annual rate of growth, raising the country's level of GDP by around 10 per cent in a decade," said Martin Feldstein, the George F Baker professor of economics at the Harvard University and the president of the National Bureau of Economic Research.

Feldstein was speaking at the 2004 LK Jha Memorial Lecture at the Reserve Bank of India. According to Feldsteint, the combined government debt is now close to 75 per cent of GDP. Large fiscal deficits, according to him, have a number of adverse consequences-- lower economic growth, low real incomes and increasing risk of financial and economic crises of the type witnessed in several countries in Asia and Latin America in the recent past.

The bad news, according to Feldstein, is that the debt to GDP ratio for India increased from 54 per cent in 2000-01 to 65 per cent in 2003-04. "Lowering the deficit and therefore the primary deficit by about 1.5 per cent of GDP can prevent the rise in the debt to GDP ratio," he said adding "Global experience shows us that a rising ratio of debt to GDP increases the probability of debt defaults or debt restructuring."

According to him, there are only three basic ways to reduce the fiscal deficit -- reducing non-interest government outlays, increase in tax or other revenue and reducing the rate of interest on the government debt. A faster rate of economic growth would also reduce the equilibrium ratio of debt to GDP and the risk of a shift to an unstable path of debt to GDP, he added.

Feldstein also pointed, "In many emerging market countries, stopping support for money-losing state owned enterprises by imposing a hard budget constraint or by privatising the entity can be a major source of spending reduction. The key to thinking about all forms of government expenditures is to recognise that the cost of providing a government outlay includes not only the direct outlay itself but also the deadweight loss associated with raising the revenue to pay for that outlay."