The reader, if she is even slightly concerned about the state of our economy must be a bit bewildered about another holy cow called fiscal deficit (FD) which, she is told, will affect her living standards and her son’s employment prospects.
In short, keeping FD in check is made out to be the lynchpin of our macro-economic stability. Even Raghuram Rajan says so! If the ordinary tax payer dare ask the reason that makes FD so critical to the Indian economy, she will be cryptically told that FD higher than three per cent for the Central government spells real trouble and so she should just endure the pain to rid the economy of this malaise.
Like medieval alchemists, reducing FD is akin to leaching the system of bad blood to cure the patient. Quite often, as we know, the patient died.
The taxpayer should be at least entitled to ask for empirical evidence or any statistical correlation between FD and growth, inflation or employment that may be adversely affected in case that Lakshman Rekha of 3 per cent is crossed.
That will be an irreverent attempt in vain. Simply because there is not a shred of evidence or analytical argument that will be presented to her as none exists.
She will be told that the risks and negative outcomes must be obvious if advanced economies of Europe have so decided at Maastricht.
It is the latest theology drummed up by foreign portfolio managers who are focused only on their next bonus.
These are the same set of investors who continued to lend to Greece until the cows came home. In any case, they provide no more than 3 per cent of our total annual investment needs.
Fiscal deficit (FD) is the excess of government total expenditure over its total earnings or revenues. Like all of us householders, we would rather that the government cuts its coat according to the available cloth.
That much is plain robust common sense. Except that, even households borrow to build assets that raise their productivity and long-term welfare.
Revenue deficit
Therefore, the right variable to focus on is revenue deficit (RD), which governments should reduce to zero as soon as possible. Governments in emerging economies have to borrow to build capital assets that will help employ legions of unemployed youth and reduce degrading poverty. All FD is not bad and the 3 per cent of GDP level is too arbitrary a criterion to merit serious attention.
It is standard theory and practice that governments have to step in to try and reverse a declining investment cycle by taking counter-cyclical public capital expenditure expansion. That creates additional capacity; crowds in private investment; and enhances productivity all of which raises the rate of growth of potential output of the economy. Additional borrowing can be balanced by raising revenues for which several feasible measures can be adopted or by pruning wasteful revenue expenditures. But that will require some bold and creative policy making and not simple status quo and lazy policy making.
The argument is made that the economy may not be able to absorb a large additional infusion of additional public capital expenditure. This sounds supremely ironical so soon after better governance and higher execution capacity was broadcast as the strongest suite of Modi government.
There are several avenues for absorbing higher public capital expenditure: national highways; modernisation of railway stations and tracks; completion of delayed construction projects; dredging of rivers, sewage and effluent treatment plants; massive slum rehabilitation with short gestation construction technologies.
These and several options exist if the will is there to push forward with higher public capital expenditure. Alternately, of course, we will continue to take solace in the spurious GDP growth numbers that are being spewed out routinely or else blame the global conditions for our inability to meet our peoples’ eminently reasonable aspirations.
The author is Senior Fellow, Centre for Policy Research
