Priorities for the coming budget

Monetary policy is now in a contractionary mode. The monetary authorities have little choice in the face of an inflation rate of around 6.7%. True, the price rise is fuelled mainly by primary articles. But, prices of manufactured products too are trending upwards. The monetary authorities can't afford to take chances. So what stance should the FM take in his forthcoming budget?

If fiscal policy is excessively contractionary, it would end up derailing growth. The fiscal deficit is declining. While the target under the Fiscal Responsibility and Management Act for 2006-07 was 3.5%, we are likely to end up lower- say, 3.2%. The temptation would be lower it further for 2007-08 and reach the target of 3% a year ahead of schedule.

That would be inadvisable. As it is, a declining fiscal deficit implies a contractionary fiscal policy. It would be wise not to overdo it. So, let the fiscal deficit for 2007-07 stay above 3%- maybe at the same level as in 2006-07. That gives room for spending on infrastructure and the social sector. This is required if supply bottlenecks are not to hobble growth in the years ahead. In sum, finance minister P Chidambaram must ensure that the budget is sufficiently expansionary to offset the effects of the ongoing monetary contraction. When I say 'expansionary', I mean: no more fiscal contraction than is mandated by the FRBM time-table.

See the full article in ET here.