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Adhering To Fiscal Deficit Target

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October 17, 2017

What is the issue?

  • India is witnessing a sharp deceleration in economic growth.
  • Fiscal stimulus is being touted as a policy measure to revive the economy.
  • However, a deeper understanding in terms of 'fiscal deficit' reveals why fiscal stimulus is not the right option.

Why a slowdown in economy?

  • There were many transient factors like the GST and demonetisation impacts for the current slowdown.
  • But besides these, one of the prime reasons is the steady and sharp decline in the investment rate.
  • Notably, public investment in recent years has shown a small rise.
  • So the lowering investment rate has largely been due to the decline in the private investment rate.
  • The Gross Fixed Capital Formation (GFCF) rate has come down in the recent quarter.

Why not a fiscal stimulus?

  • A fiscal stimulus is one in which the government spends more from its own pocket or slashes tax rates to boost a sluggish economy.
  • This results in more money in the hands of consumers, and as a result spending goes up, thereby encouraging demand and growth.
  • There are opinions that a strong fiscal stimulus through an increase in public investment and a relaxation on the fiscal deficit obligation is needed.
  • However, an understanding of the real factor behind slowdown as said above, demands policy initiatives for raising the private investment.

Why is relaxing fiscal deficit target risky?

  • Borrowing space - The prime focus of fiscal deficit targeting is to ensure that the private sector has sufficient borrowing space.
  • Increasing government debt and increasing interest rates reduces the credit available for businesses.
  • Also, government selling its securities, such as Treasury bonds to finance its debt absorbs the available funds from the private sector.
  • So, widening fiscal deficit would only narrow the borrowing space and reduce private investment at a time when it has to be boosted.
  • Debt-GDP ratio - Government has set a target of debt-GDP ratio at 60% in 2023 from the present level of 70% .
  • This requires the Centre and States to contain their debt-GDP ratios at 40% and 20%, respectively.
  • This is achievable only by limiting the fiscal deficit at 3% of GDP in the first three years and 2.5% in the next two years by the Centre and States.
  • Revenue deficit - Over 60% of the estimated fiscal deficit at the Centre in 2017-18 (1.9% out of 3.2%) is revenue deficit.
  • At the State level also , the revenue deficit is only expected to increase.
  • This is because of the impact of loan waivers, additional interest payments on account of UDAY scheme, and pay revision as per 7th pay commission.
  • Given all these, any additional fiscal stimulus measures would only widen the already increasing revenue deficit.

What lies ahead?

  • India's economic history is replete with adverse effects of fiscal expansion on inflation as well as the balance of payments.
  • The huge fiscal expansion in the late 1980s and 2008-09 have led to some serious economic crisis besides the benefits.
  • Clearly, the solution to the current slowdown in growth lies in:
  1. reviving private investment.
  2. recapitalising banks to enable them to lend more.
  3. speedy completion of stalled projects.
  • The fiscal deficit rules evolved are consistent with the level of savings and the demands of the various sectors on those savings.
  • So, fiscal prudence is crucial for sustaining growth over an extended period.
  • In this challenging economic situation, any aggressive attempt to widen the fiscal deficit would only worsen India’s economic problems.

Quick Facts

Fiscal Deficit

  • Fiscal deficit is the difference between total revenue and total expenditure of the government.
  • It is an indication of the total borrowings needed by the government (so as to finance the deficit).
  • Fiscal deficit takes place either due to revenue deficit or a major hike in capital expenditure.

Gross Fixed Capital Formation (GFCF)

  • Gross fixed capital formation is essentially the net investment.
  • GFCF refers to the net increase in physical assets (investment minus disposals) within the measurement period. 
  • It does not account for the consumption (depreciation) of fixed capital, and also does not include land purchases.
  • It is a component of the Expenditure method of calculating GDP and measures the net increase in fixed capital.

 

Source: The Hindu
1 comments
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PP 8 years

Presented  a simple issue in simplest form from a very complicated editorial text. I loved it. Thank you. 


I have ONE doubt though,

I usnderstood from the editorial that - Fiscal stimulus is not the key, as culprits are private investers. But, Can anyone explain how exactly it (fiscal stimulus) will narrow down the borrowing space of private sector?

what i see is, fiscal stimulus -> more money in market -> more demand -> more supply -> rcovery..

so how it will narrow down the borrowing space, its just - private players are sidetracked here!



IAS Parliament 8 years

1. Fiscal stimulus -> more money in market -> more demand -> more supply -> recovery....is right. • However the point here is “how sustainable can fiscal stimulus a solution be???” • Fiscal stimulus could boost the economy temporarily, but increasing fiscal deficit would pull down growth in the longer term. • The prospects for economic growth once the stimulus wears off is also uncertain.

IAS Parliament 8 years

2. Fiscal deficit is an indication of the total borrowings needed by the government (so as to finance the deficit). • Clearly, increasing fiscal deficit would later on necessitate the government to borrow more. • Government, by selling its securities, such as Treasury bonds to finance its debt, will absorb the available funds. Hence the borrowing space for private players get narrowed down • Given all these private players get crowded out. • Since low private investment rate is a major reason for the current slowdown, this could become unfavourable for a healthy economy.

PP 8 years

Awesome! Got it! Its just

IAS Parliament 8 years

Thank you. Keep Reading