The Gold Standard | Fiscal deficit irrelevance

Authors Devina Mehra and Shankar Sharma have written a rather disappointing piece on India’s fiscal deficits. Surely, it is not ignorance of economics that has led to the arguments that they make. Here are some counter-arguments:

(1) Fiscal deficits are, per se, not bad. They may be good, if moderate, and if they boost potential growth or the non-inflationary growth rate of the nation. UPA fiscal deficits fail on both counts. The Reserve Bank of India now estimates that India’s potential growth rate to be 7% rather than 8% or higher. Surely, that one argument alone is sufficient to discredit the fiscal deficit record of the UPA regime.

(2) It is mischievous to suggest that the debt-to-GDP ratio worsened under the NDA administration and has improved under UPA. UPA enjoyed the benefits of global growth boom and the lagged effects of infrastructure spending and other reforms undertaken during the NDA regime. For economists failing to take into account and acknowledge lag effects is a serious omission.

(3) Rural consumption growth is good provided it is sustainable. Second, it need not and should not come at the expense of creating rural assets. Yes, China might have over-invested but the answer to that is not that India should over-consume. There is a golden mean to both. The alternative for India’s consumption-investment imbalance is not China’s investment-consumption imbalance. The authors deliberately set up a strawman to knock it down.

(4) Subsidies are good provided they fulfill the stated objectives that they are intended for. A near 50% leakage and wastage of food under the Public Distribution System is no one’s definition of welfare or growth-enhancing subsidy. How much of subsidised diesel goes to power pumpsets and how much of it powers four-wheel drive vehicles on Indian city roads? Even if all of them go to power pumpsets, is it good? What happens to water tables and excessive water logging in Indian paddy fields?

(5) Part of the deficit growth under the UPA regime has occurred due to the farm loan waivers granted some months before the 2009 elections. Recently, the Chairman of the State Bank of India stated in a conference hosted by this newspaper that it has damaged attitudes towards loan repayments among farmers. Non-performing agricultural loans are rising and that is because farmers expect another loan waiver. Does that augur well for flow of credit to the sector, its future production and national economic growth prospects? We have blogged on it here.

(6) The National Employment Guarantee Programme that does not create assets has led to widespread labour shortages and destroyed work ethics. Many studies – some done by this newspaper – have documented that. Anecdotal evidence from entrepreneur-friends reinforces evidence from macro surveys.

(7)  If the economic growth rate under the NDA regime was low and there were some significant negative growth shocks during that period – 9/11 impact, US recession, global slowdown, technology sector slump, drought in 2002, sanctions for the 1998 nuclear test by India and launch of the war on Iraq by the US and its allies – then it makes the case for deficit spending to pick up the slack.

In contrast, economic growth under UPA regime since 2004 was good.  [Pl. note that it is incorrect to credit the government for that. It happened due to the lagged effects of reforms and infrastructure spending under the NDA regime and solid global growth during that period]. In periods of good economic growth, there is no need to augment it further with fiscal deficits. That is wasted stimulus. Far from patting the UPA for its so-called record on government debt, the authors should have pulled the government up for its lack of seriousness in using good times to save for the rainy day. Adding to domestic demand when not necessary is to keep the doors open for higher inflation.

(8) Surely, the authors do not think that the Reserve Bank of India is ignorantly pushing the line that the government’s fiscal profligacy has added to inflation pressures and complicated their monetary policy management? Perhaps, they have not had the time to read Dr. Subbarao’s seminal speech on the monetary policy trilemma. The Reserve Bank of India has had to monetise the government borrowing and thus be an unwilling accessory to the government in stoking India’s inflation pressures.

(9) It is a fact that the government deficit and the consequent borrowing have crowded out the private sector. They have resorted to foreign currency borrowings. Their questionable accounting practices (permitted by relevant authorities, of course) created a temporary spike in demand for US dollars, sent the rupee plummeting and have raised India’s import costs. The government’s fiscal deficit has had a role in rupee weakness thus, not to mention its contribution to the perception of India’s mounting macro-economic risks.

(10) Government of India’s fiscal deficit contributed directly and indirectly (by stoking aggregate demand) to India’s current account deficit. One can argue that 3.6% current account deficit – GDP ratio is not a high external deficit ratio. What is high or low is actually a function of how much of it is the market willing to finance. Clearly, India looks vulnerable now on the external funding angle.

(11) With all their acts of omission and commission, the two UPA governments have damaged India’s macro and micro-economy. Consequently, India faces the prospect of lower economic growth rate in the years ahead. Then, if the UPA were to be voted out of office in 2014, India’s lower economic growth rate might coincide with another non-UPA administration at the office. Voila! That would prove the authors’ point that UPA’s deficits have been good for India!


DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.