Adhering To Fiscal Deficit Target

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