Do fiscal deficits reduce economic growth?

The debate between the Planning Commission's deputy chairman and the finance minister on postponing deficit reduction targets carries on.

AJAY SHAH
Independent Scholar

Fiscal consolidation has meant a huge hike in savings since 2001-02 - this is what made the remarkable GDP growth possible

From 1991 onwards finance ministers Manmohan Singh, P Chidambaram, Yashwant Sinha, Jaswant Singh and then P Chidambaram engaged in a mighty battle with the fiscal deficit. Why should India grapple with fiscal deficit?

In 2001-02, the savings of the public sector added up to a loss of Rs 46,377 crore. In 2004-05, this had swung around dramatically: the government and the public sector enterprises saved Rs 69,390 crore. This was a shift from -2.0 per cent of GDP to +2.2 per cent: an enormous swing of 4.2 per cent of GDP. In parallel, India also got an additional 1.6 per cent of GDP by switching from a current account surplus (i.e. export of capital) to a more sensible current account deficit. Overall, we got an investment rate in 2004-05 which was 30.1 per cent of GDP "" the highest ever in India's history. Investment in 2004-05 was a full 7 per cent of GDP bigger than the level in 2001-02.

This sharp rise in investment is our first fruit of the resolve of four finance ministers over 15 years. It is a key source of the remarkable GDP growth rates of the recent few quarters. Fiscal consolidation is no longer all pain with a promise of future gain. We have tasted the results: we have seen how fiscal consolidation yields higher investment, and higher investment yields higher growth. The irresponsible fiscal policies which are being advocated today are increasingly dangerous in this age of globalisation. Globalisation has transformed India's growth opportunities. But at the same time, we can be punished by high real interest rates and expensive equity capital if the world perceives that our house is not in order. A particularly lethal combination would be a high fiscal deficit coupled with an exchange rate that is manipulated by the RBI: this could yield a classic third world currency crisis.

As Martin Feldstein observed in Mumbai in 2004, a country with a high fiscal problem is like a fat man. Obesity hurts in an insiduous way through diabetes, blood pressure or heart disease. But the irresponsible fat man always says that he is fine, and one more helping of ice-cream never seems to hurt. In a similar situation, it is pretty easy for an irresponsible politician to peddle one more big expenditure programme, despite accelerating inflation.

India is approaching a point of explosive growth owing to demographic factors and the gains from globalisation. If the FRBM is violated, it will be an enormous loss of credibility for India's institutional capacity, and this unique opportunity can be squandered. What we need most at this juncture is the fiscal policy used in England when they were a developing country: this involved running a surplus every year, except in times of war.

TCA SRINIVASA-RAGHAVAN
Columnist

India's run a high fiscal deficit since 1995 and is doing fine - financing it by borrowing abroad is the real issue

Far too much fuss is made over fiscal deficits. Maybe this is because most of our current policy economists have been trained in the Fund-Bank orthodoxy, which is largely aimed at protecting overseas US investments from sudden and large devaluations that "large" fiscal deficits can induce via the current account deficit or high domestic inflation.

The purists say a large fiscal deficit will either cause inflation or a balance of payments problem. But a great deal depends on the composition of expenditure, not to mention Uncle Sam who can decide to squeeze your liquidities for defying Him. So the answer to deficits lies in increasing productivity and/or not in annoying Washington DC. The latter is more important, I think.

Fiscal fundamentalists also talk of sustainable levels of the deficit, which is 5-5.5 per cent of GDP for the centre and the states combined. Well, the gayatri mantra is supposed to be recited 108 or 1,008 times. No one has ever told me where this number "" or the 3-3.5 percent figure "" came from. As long as governments have assets to sell, relax, but don't finance the deficit by overseas borrowing, is my advice.

One way to reduce the deficit, say the funders and the bankers is to sell the public sector. But the best asset to sell, is urban land. Also unlike the public sector, our taxes didn't create it and it employs no one. States' governments have always done it. The SEZs are the latest case in this point. There's no reason why the Centre can't do it.

Then, there's the subsidy-equity issue. You have to be poor to understand why subsidies are important. But very few "Fund-Bank" type economists are poor. Still, I suppose they can always talk to their bais to find out. How many do? A survey, anyone?

Subsidies don't reach the masses, they say, perhaps rightly. But the little that does trickle down keeps the great unwashed from rebelling. What value do you attach to the illusion that prevents such upheavals? Ask Louis XVI.

The point, in case you are very obtuse, is this: the government is a multi-product services enterprise producing, among other things, social peace. All multi-product firms cross-subsidise their products. Ergo, why can't the government do it? That it contains the largest concentration of rogues and idiots cannot be an argument against subsidies.

The silly response to all this is "Oh, you mean you can run as high a deficit as you want?" Of course not. All I am saying is don't let it turn into an obsessive compulsive disorder. After all, since 1995 India has run into high deficits and is doing fine. And as long as it doesn't annoy the US , yes, it will continue to do so.