In a developing economy, the government will always find compelling reasons to spend more, but it should not lose sight of the larger goal of maintaining macroeconomic and financial stability.
In the absence of Union minister Arun Jaitley, his colleague Piyush Goyal will present the interim Budget on February 1. But the change of guard at the North Block has not altered economic realities. In fact, complications for the ruling alliance have gone up after the Congress President Rahul Gandhi's announcement of giving a basic income to the poor if his party is voted back to power.
However, it will be important for the government to not get swayed by the promises made by the opposition and overcome immediate political compulsions. The most critical thing that financial markets would be looking at will be: how the government intends to manage its finances in the remaining part of the current financial year and the next fiscal. The government needs to contain the fiscal deficit at indiabudget.gov.in/ub2018-19/frbm/frbm2.pdf">3.3 percent of the gross domestic product (GDP) in the current year, and bring it down to 3.1 percent of GDP in the next fiscal.
It is correct that there is stress in the farm sector and it needs policy attention. Also, the government would want to increase spending in a number of other areas in an election year. But there are strong reasons why it should adhere to the fiscal consolidation roadmap.
First, problems in the agriculture sector are more fundamental in nature and need long-term solutions. Increasing expenditure in terms of debt relief, or some kind of income support, as is being reported, is unlikely to solve the problem. The agriculture sector needs structural solutions and a lot will have to be done outside the budget. For instance, it is important to establish India as a single market for agricultural products.
Second, the economy is growing at close to its potential and, according to the projections of the International Monetary Fund, growth will strengthen in 2019 and 2020. Further, core inflation is running close to the upper limit of the tolerance band of the Reserve Bank of India. Therefore, a push to aggregate demand at this stage could become inflationary and limit the possibility of monetary easing. A higher cost of money will limit the impact of a fiscal push to growth.
Third, even though there has been consolidation in central government finances, the budget deficit in the states has gone up in recent years. As a result, the combined deficit continues to remain elevated. A further escalation will not only increase the risk to macroeconomic stability but also crowd out private investment. As economist Sajjid Z. Chinoy has shown elsewhere, total borrowing by the public sector—including the centre, states, central public sector enterprises, and off-balance sheet—at 8.2 percent of GDP in 2017-18 was at the same level as five years ago. A lower government borrowing will leave more resources for the private sector to invest, which will help push growth in the long run.
Fourth, it is important to have some fiscal space to deal with uncertainties, such as a sudden rise in crude oil prices. Government finances would have come under significant strain if oil prices remained elevated in 2018. The government would be in a position to deal with such contingencies only if it has fiscal space. However, if its finances are constantly on the edge, the lack of fiscal space can significantly affect market confidence.
Fifth, according to the changes in the Fiscal Responsibility and Budget Management Rules, as recommended by the NK Singh committee, the government can breach the target in cases such as a war, national calamity, or a decline in real output. However, none of these happened this year and do not provide any reason to revise the target for the next year. Therefore, a deviation from the deficit target will not only affect the credibility of the government but also the budget process.
In a developing economy, the government will always find compelling reasons to spend more, but it should not lose sight of the larger goal of maintaining macroeconomic and financial stability. The Modi government has done well by bringing down the fiscal deficit, which has helped strengthen macroeconomic stability, and should continue to move forward on the fiscal consolidation path.
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