Enamoured by the country’s growing global presence many Indians seek to replicate or imitate at home any new tendency in the international arena. The most recent such import is the “exit debate”, or debate around the question whether it is time to roll back the fiscal stimulus that was put in place to stall and reverse the downturn that resulted from the global crisis. The argument seems relatively simple and straightforward. Unusual times called for unusual measures, but now as the economy returns to ‘normal’ growth the extraordinary expenditures must be reversed to rein in the fiscal deficit. Besides the view that deficit financing per se is bad policy, there are three assumptions underlying this viewpoint. First, that the fiscal stimulus resorted to in the wake of the downturn was large. Second, that this stimulus was responsible for the increase in the deficit on the central government’s budget. And, third, that the only way to deal with the problem is to curtail expenditures.

The notion that the stimulus was large and responsible for the widening of the deficit on the Central budget was, in fact, promoted by the government. For example, in his budget speech delivered on July 6, 2009, Finance Minister Pranab Mukherjee endorsed this view when he said that “fiscal accommodation” in response to the crisis had resulted in a sharp increase in the fiscal deficit from 2.7 per cent in 2007-08 to 6.2 per cent of GDP in 2008-09 and estimated that the total fiscal stimulus (equal to 3.5 per cent of GDP at current market prices) in 2008-09 amounted to Rs.1,86,000 crore.

This is, of course, a gross exaggeration, inasmuch as it presumes that all of the increase in the fiscal deficit in excess of the growth in nominal GDP was entirely the result of the stimulus motivated by the downturn in growth. It is indeed true that 2008-09 did see a significant increase in expenditures with non-plan expenditures in particular rising by 23 per cent relative to the revised expenditures for 2007-08. However, two heads of expenditures that accounted for the bulk of this increase, namely subsidies and the implementation of the Sixth Pay Commission’s recommendations, had little to do with the stimulus motivated by the downturn. Though the exact figure of the burden imposed by the Sixth Pay Commission’s recommendations is difficult to come by, the Commission itself had estimated that the payment of the new salaries and half of the arrears during 2008-09 would result in additional expenditure of about Rs. 21,500 crore, which amounts to around 18 per cent of the actual increase in non-plan expenditure in that year. And the huge increase in subsidies resulting, among other things, from higher minimum support prices and larger procurement during that year added another Rs. 59,500 crore to the non-plan expenditures head, or a little more than half of the increase in those expenditures.

In sum, around 70 per cent of the increase in non-plan expenditures had little to do with the stimulus per se, rendering the Finance Minister’s generous estimation of the size of the stimulus completely wrong. The real impact of the downturn was to be seen in the slower rate of growth of revenue receipts which fell to just 7.7 per cent in 2008-09 as compared with 24.7 per cent in 2007-08. This obviously meant that the higher non-stimulus-driven expenditures in 2008-09 resulted in a sharp increase in the fiscal deficit.

So it is not a higher fiscal deficit resulting from an unavoidable fiscal stimulus that is the problem facing the Indian economy today. The problem is that expenditures that are not easily reversible, if at all, such as higher salaries and higher subsidies, are responsible for the increase in the deficit. It is likely that expenditures under some of these heads may increase further this year. High cost imports necessitated by the drought during the kharif season and the implementation of the proposed Food Security Act are likely to raise the outlay on food subsidies during fiscal 2009-10. Expenditures would rise also because of the higher interest payments necessitated by the additional borrowing undertaken to finance last year’s fiscal deficit. And lower growth would push up the deficit to GDP ratio even further. In these circumstances, even the Finance Minister’s fond hope that he can restrict the fiscal deficit to 6.8 per cent may remain unrealised. Yet, pressure is mounting to reduce the deficit and adhere to the fiscal deficit to GDP ratio targets set by the Fiscal Responsibility and Budget Management Act.

If despite the fact that it is not the stimulus per se that is primarily responsible for the fiscal deficit at the Centre, the government succumbs to the pressure to “roll back the stimulus”, then the impact would fall on plan expenditures in general and capital expenditures in particular. In fact, the trend over a long period has been for the ratio of capital expenditures in the Centre’s budget to fall relative to GDP, and even in 2008-09 when revenue expenditures (as a proportion of GDP) rose sharply, capital expenditures fell. This hardly constitutes an appropriate strategy from the point of view of ensuring recovery and sustained growth.

If fiscal conservatives believe that the fiscal deficit is India’s problem No. 1, then they should perhaps focus on ways of raising additional resources to finance unavoidable expenditures, rather than on ways of reducing government spending substantially.