Reserve Bank of India Governor Urjit Patel ’s emphasis on the vital importance of protecting domestic macroeconomic stability could not have come at a more crucial juncture. With the Centre in the process of finalising the Union Budget, Dr. Patel has stressed the need to ensure that it does not stray from the path of fiscal consolidation, at a time when the external environment is already adverse and likely to remain uncertain for the foreseeable future. That the clamour for a sizeable fiscal stimulus is likely to grow louder as budget day nears is a certainty, given the signs that an incipient demand slowdown may have been exacerbated by the cash crunch caused by the withdrawal of high-value banknotes. Within the government too, the temptation to loosen the purse strings to assuage adverse reaction to the demonetisation decision is likely to be high. It is in this context that the RBI chief’s reminder to the Centre that “borrowing even more and pre-empting resources from future generations” cannot be a short cut to achieving durable long-term “higher growth” is significant. With the general government deficit among the highest in the G-20 economies, Dr. Patel reiterated what several of his predecessors including Y.V. Reddy have harped on: high levels of government borrowing tend to crowd out private investment and paper over the urgent need for more abiding reforms.
Specifically, the RBI chief has suggested that government expenditure be ideally reoriented towards creating more public infrastructure such as expanded railway networks and urban mass transit systems that would help boost productivity even as it leads to reductions in the oil import bill and provides the collateral benefit of improved air quality. And in what could be seen as an expression of assertion of the RBI’s independence of thought, Dr. Patel spoke of the risks that policy interventions in the form of government guarantees and interest rate subventions pose. While not directly alluding to Prime Minister Narendra Modi’s announcements last month, which included a doubling in credit guarantees for micro, small and medium enterprises, the RBI chief said that “large credit guarantees also impede optimal allocation of financial resources and increase moral hazard.” With such guarantees only adding to the government’s liabilities and raising the risk premium on its borrowing, the better solution, he suggested, would be to resolve constraints such as transaction costs related to clearances and the taxation bureaucracy. As Dr. Patel said, “it is easy and quick to fritter away gains regarding macroeconomic stability”. But, as he added, it would be “hard and slow to regain them”.