Monday, February 22, 2016

Forthcoming budget: pause on fiscal consolidation must continue

Should the FM stick to the target for the fiscal deficit of 3.5% for the coming year or not? A furious debate has been raging for the past several weeks. The balance of advantage, in my view, lies in departing for the target for two purposes: higher investment spending and infusion of capital into banks at a level higher than planned Indradhanush (Rs 25,000 crore).

There are two arguments put forward against such a course. One is that foreign investors will take fright if the deficit ends up, say, 3.7% or 3.8% instead of 3.5%. This is not very persuasive considering that we were supposed to have ended up at a fiscal deficit of 3% way back in 2008. If a departure for so many years has not resulted in investors abandoning India, it's hard to see why they should want to do so when the Indian economy stands out amongst major economies in terms of its growth rate.

The second argument is that there are not really worthwhile investment projects that the government can take up. So, a higher deficit is bound to translate into higher consumption. There are ways of addressing this concern. Let the budget list some high priority projects. It is easier, of course, to put a figure on infusion of capital into public sector banks. Let the FM commit to giving a quarterly report on the investment that is happening in the projects mentioned in the budget. With this sort of transparency, the anxieties of foreign investors can be allayed.

We are staring at deceleration in growth consequent to the problems in the world economy at large. If growth dips below 7% in the coming year, we could face serious problems. Investors would be more inclined to pull out. Banks' NPA woes would mount. The government's fiscal position would worsen. An acceleration in growth, on the other higher, would act as a tonic. It would mitigate banks' problems and it would also create conditions for greater sell-offs of PSUs. The risks to macro-economic stability from a falling growth rate are greater than any risks attaching to a departure from the fiscal consolidation path.

More in my article today in the Hindu, To grow or not to grow.


Anonymous said...

Public sector investment can provide an opportunity to increase spending on basic physical infrastructure and also drive financial inclusion. Assuming these investments are financed by debt, what are the possibilities that these investments will have positive impact on private sector productivity, and offer a higher rate of return than those of private capital in the long run?

T T Ram Mohan said...

Higher public investment in infrastructure carries the promise of crowding in private investment in various areas. We don't know that the rate of return will be higher than on private investment. But the point today is that private investment is simply not forthcoming for a number of reasons.So if want to prevent a further slide in the growth rate, we need public investment to rise.


Anonymous said...

Hi Prof,

Thanks for the thoughts ! ... Bringing in budget transparency in explaining allocation would go a long way in helping allay some of the fears of Investors. somehow there is a need to push up the savings rate as well. I donot also understand why we donot have the a robust captial gains tax structure in india as well especially long term capital gains. It will also reduce the incentive to trade in a speculative manner.

on a side note ... I also viewed your participation on the show "Macros with Mythili".. was surprised even seasoned journalists actually tend to oversimplify things like "Budget is being political in nature" ... as if it should be something else.

- Deepak

T T Ram Mohan said...

Hello Deepak, Yes we need to revisit capital gains. The argument against levying a long-term capital gains tax has been that it doesn't bring in substantial revenues, so why tinker with investor sentiment. But not having such a tax has implications for inequality- you are not, in some way, taxing the wealth of the rich.

About budgets, you are right- not just lay persons but economists would like to think that politicians should not have a decisive say in these.