Fiscal activism

Govt should tread carefully on this path

The Economic Survey, tabled in Parliament on Friday last week, expects the economy to rebound in the next fiscal year with a real growth rate of 11 per cent, after contracting by 7.7 per cent in the current year. In nominal terms, the economy is projected to expand by 15.4 per cent. Union Finance Minister Nirmala Sitharaman is likely to use these numbers in the Union Budget, to be presented on Monday. The projections in the Survey are largely in line with other forecasts. The International Monetary Fund, for instance, expects India to grow by 11.5 per cent in the next fiscal year. Despite a projected “V-shaped” recovery, gross domestic product (GDP) next year would only be about 2.4 per cent higher than the absolute level of 2019-20.

While a sharp decline in new Covid infections and the vaccination roll-out programme are likely to boost economic activity, the economy would still need support to fully recover from the shock. Therefore, the most important aspect of the Budget perhaps would be to the extent the government is willing to support the economy through fiscal means. The Survey called for an active counter-cyclical fiscal policy, and noted that it wanted to provide an intellectual anchor to the government to be “more relaxed about debt and fiscal spending during a growth slowdown or an economic crisis”. It further argued that growth leads to debt sustainability, not the other way round. The basic idea is that if the cost of government debt is less than the growth rate, a fiscal policy providing impetus to growth would result in a lower debt-to-GDP ratio.

There is no dispute that governments should support the economy at the time of a contraction or severe cyclical slowdown. But India would do well to tread carefully on this path because of a variety of factors. The government has done well to adopt a relatively cautious fiscal approach during the current year. The general government debt-to-GDP ratio in the current year, however, is still expected to expand to about 90 per cent. To be sure, one of the reasons why the government could not spend more in the current year is the existing higher general government deficit. Thus, since the economy was rapidly losing momentum even before the Covid crisis — despite a higher deficit— it is not obvious that higher government spending would necessarily result in higher sustainable growth. Increased commitment to interest payment could worsen the quality of expenditure and affect growth in the coming years. Further, as Volume II of the Survey showed, despite having a favourable interest rate-growth differential, the general government debt went up from 67.4 per cent of GDP in 2011-12 to 73.8 per cent in 2019-20. Bringing down the debt level might need very high economic growth, which may not materialise over the medium term.

It is also worth noting that India normally finds it difficult to roll back expansionary fiscal policy. Besides, both the Central and state governments have created large off-budget liabilities over the years and those will have to be repaid at some point. Therefore, while the government needs to support the economy in recovering from a truly unprecedented shock, it should not lose sight of its own balance sheet vulnerabilities, which could potentially increase risks. One of the ways Monday’s Budget will be judged is how the finance minister strikes the desired balance.