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As a ravaged economy gears for a restart from the onslaught of the Coronavirus pandemic, all eyes are on the government and how it will use its fiscal policy. With tax revenues falling sharply and expenses mounting day by day, the government finds itself dealing with a trade off between increasing demand and keeping its deficit in check. In such a scenario, it has chosen the latter and focused on fiscal stability by broadly staying within the guidelines of Financial Responsibility and Budget Management (FRBM) Act. This decision to stay financially prudent has attracted its fair share of attention, with many welcoming the stability it brings, and critics pointing out the policy’s myopic nature.


At a time when consumer spending and private investment is at an all time low, the onus lies on the government to try to revive the economy and bring the GDP back to the desired level. Maintaining fiscal discipline at such a time therefore harms the government more in the long term – due to reduced future growth rates and the resultant lower tax collections. The government’s decision to prioritise low inflation and balance the budget has even been criticised on a theoretical level. This is because inflationary pressures only build up at the full employment level and the economy is far from it. Additionally, the actual fiscal stimulus in terms of direct benefit transfers and public works projects is just a mere fraction of the 20 lakh crore package and the government has shown great restraint in its outlays. This dearth of spending could prove to be very costly as these transfers and infrastructure schemes had the potential to stop a prolonged slowdown by boosting incomes and employment. Not spending more will only worsen the future government debt figures as growth is likely to be low for a long period.


One key reason for the ‘weak’ fiscal response is the already high debt-to-GDP ratio, which is the highest among the BRIC nations. Moreover, at a time when Moody’s has downgraded India’s sovereign bonds from Baa2 to Baa3 (which is the lowest in the investment grade), increasing fiscal deficit may lead to further downgrading. This makes India very vulnerable to capital flight and will severely damage an already weak rupee. Therefore, fiscal restraint is not a mere policy choice for the government, but also a compulsion in order to mitigate capital and currency risks, and protect the economy. The government has already reached 83.2% of annual target for budget deficit set under the Financial Responsibility and Budget Management (FRBM) Act, which further constrains its ability to respond. Even if the FRBM’s constraints are relaxed, India would find it very difficult to raise funds due to its bad credit rating. Also, many experts feel that demand side fiscal stimulus would be very ineffective at a time when there is a lot of uncertainty in the economy and the government should wait for the response after the development of vaccine. This is because people are unwilling to spend in an uncertain environment and would instead increase their savings. Any additional income as a result of stimulus packages, would only be absorbed by savings and economic growth would be unaffected.


The government’s argument for restricting expenditure and keeping a low deficit definitely has some merits, but this just means relying on ordinary measures in extraordinary circumstances. By adhering religiously to the FRBM Act, it digs a deeper hole for itself by limiting potential avenues for financing its debt. For example, the practice of RBI directly monetising the debt by purchasing government bonds in the open market (banned under the FRBM Act), can certainly be revisited to increase the prospects of relaunching the economy. While this may carry currency risks and damage the deficit in the short run, these are costs that the government has to endure. And while the government’s approach to maintain fiscal stability in such uncertain times deserves praise, this stability should not come at the cost of India’s medium to long term growth.

By Iman Bhatti


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