Run a Larger Fiscal Deficit!

The Economic Times     8th February 2021     Save    

Context: Union budget for 2021-22 targets fiscal deficits of 6.8% which is acceptable, and even a bigger deficit is feasible with a high Gross Domestic Product (GDP) growth target.

Arguments against large fiscal deficits:

  • Low deficit is often preferred: International Monetary Fund (IMF), Rating agencies and the Fiscal Responsibility and Budget Management (FRBM) Act, 2013 recommends fiscal deficit close to 3.5%.
    • As India’s fiscal deficit zoomed from 4.6% of GDP in 2019-20 to 9.5% in 2020-21.
  • Chances of higher inflation and interest rates: debt-financed increased public spending raises the spectre of higher inflation and interest rates.
    • While the subsidies and redistributive entitlement programmes are politically popular and increase consumption demand, they rarely yield productivity and results in higher inflation.

Argument favouring large fiscal deficits: For reviving from Covid-19 economic shocks.

  • Low debt-to GDP ratio: Compared to other economies; while India is at 85%, Many G20 nations, including the US, Japan, Britain, and Brazil have debt-to-GDP ratios at, or above, this threshold.
    • A Covid-rebound GDP growth rate of 14.4%, will arrive at a fiscal deficit of 12.2% — equal to 85% debt-to-GDP times 14.4% GDP growth — that will leave the debt-to-GDP ratio unchanged.

Ways to ensure deficit financing will not harm the economy:

  • Ensure spending on enhancing productivity: Unless government expenditures enhance productivity, they only fuel inflation.
    • Public spending to areas where the private spending is low: i.e. the areas where the benefits are hard to capture or the operating cycle is long. This will help to sidestep the Inflation Trap.
      • E.g. in public works for more stable electricity, faster transportation and soft infrastructure (education, and legal and (de)regulatory infrastructure facilitating ease of doing business).
    • Expenditure should remove infrastructure and regulatory bottlenecks: to spur the economy.
    • Route expenditure through private sector: It would help realise efficiency gains.
  • Improve legal infrastructure by expanding the judiciary: Public investment in the judiciary would unclog regulatory and contractual bottlenecks, and unleash private investment, domestic and foreign.
    • According to a retired Supreme Court justice, about 33 million cases are pending in courts.
    • 2014 Law Commission of India report suggested doubling the judiciary's size by adding about 20,000 new judges.

Conclusion: Additional financing should be expended well for a successful deficit financing strategy. It is high time for India to be bold and invest in creating conditions that will stimulate further economic activity.