It’s Goodbye to Fiscal Orthodoxy

Context: Budget 2021 is a departure from the orthodox market stability  and fiscal consolidation stance.

Analyzing the change in the fiscal stance of India (in Budget 2021-22)

• Move away from market orthodoxy:
  • Increased duties on some imports to protect and foster the domestic industry.
  • Introduced Performance­Linked Incentives for designated sectors counter to market economics.
• Adherence to the market orthodoxy: by continuing with privatization and increasing role of Foreign Direct Investments (FDI).
• Move away from the fiscal consolidation: Yearly projections of fiscal deficits are missing; the Finance Minister has promised to introduce an amendment to the Fiscal Responsibility and Budget Management (FRBM) Act 2003.
• Move away from the Washington Consensus: based on macroeconomic stability (means that government budgets need to be broadly in balance so that borrowings to finance the deficit are kept to a minimum).

Arguments in favour of fiscal expansion:

• Favoured by The Economic Survey:
  • It quotes economist Oliver Blanchard – “ If the interest rate paid by the government is less than the growth rate, then the intertemporal budget constraint facing the government no longer binds.”
    • Interest Rate-Growth Differential (IRGD): if negative, that means economic growth rate is more than interest rate on the borrowings.
    • The Economic Survey argues that in India, the growth rate is higher than the interest rate most of the time.
  • It says that, in the current situation, expansionary fiscal policy will boost growth and cause debt to GDP ratios to be lower, not higher. (no need to worry about debt)
• Favoured by the World Bank (WB) and International Monetary Fund (IMF): amidst the pandemic.

Associated concerns:

• Downgrade in India’s ratings: unless the rating agencies have decided to toe the IMF-World Bank line on fiscal deficits.
• Possible rise in inflation: due to large fiscal deficit which will require a change in the inflation target of 4% set for the Reserve Bank of India.
• Privatization:
  • Unachieved targeted revenue: E.g., the sale of Air India is dragging on since 2018.
  • Politically contentious: due to allegations of favouritism and political importance of public sector unions. Job losses further evoke backlash.
  • Privatization of banks raises concerns about financial stability.
  • Against the aim of Atmanirbhara Bharat: as large-scale privatization almost always brings substantial FDI as seen in economies of South East Asia and Eastern Europe.

Conclusion: A departure from fiscal orthodoxy is welcome, but the government needs to think of ways to make it more sustainable.