A whopping fiscal deficit at 9.5% of GDP for FY21 highlights departure of India’s fiscal policy from the path of fiscal consolidation. The article highlights the issues related to such departure.

Important departure

• With its fiscal deficit at 9.5% of GDP for FY21 and 6.8% in FY22 Budget for 2021-22 seems to signal “spend like there is no tomorrow”.
• For well over a decade-and-a-half, we have tried attaining deficit targets set out in the Fiscal Responsibility and Budget Management (FRBM) Act (2003).
• In this Budget, target of FRBM Act has not been adhered to.
• The Budget thus marks an important departure from one of the key tenets of the Washington Consensus that was based on macroeconomic stability.
• In previous years, Medium Term Fiscal Policy cum Fiscal Strategy Statement would give the indicators for the past two years as well as the projections for the next two years.
• In this year’s Budget, the yearly projections are missing.
• The Finance Minister has promised to introduce an amendment to the FRBM Act to formalise the new targets.

The theoretical basis for departure

• The Economic Survey laid the groundwork for a departure from rigid adherence to fiscal consolidation. 
• It has a quote from economist Olivier Blanchard, “If the interest rate paid by the government is less than the growth rate (IRGD), then the intertemporal budget constraint facing the government no longer binds.”
• The “intertemporal budget constraint” means that any debt outstanding today must be offset by future primary surpluses.
• The Survey argues that in India, the growth rate is higher than the interest rate most of the time. 
• The Survey says that, in the current situation, expansionary fiscal policy will boost growth and cause debt to GDP ratios to be lower, not higher.

Key concerns

• An important factor for adhering to the fiscal constraint in the past was the fear that the rating agencies would downgrade India if total public debt crossed, say, 10%-11% of GDP.
• That is a risk that cannot be wished away unless the rating agencies have decided to toe the IMF-World Bank line on fiscal deficits.
• Another concern is that a large fiscal deficit can fuel a rise in inflation.
• A third concern is that, with the tax to GDP ratio not rising as expected, the sale of public assets has become crucial to reduction in fiscal deficits in the years ahead. This is a high-risk strategy.
• A large-scale privatisation almost always involves substantial FDI.
• In South East Asia and Eastern Europe, privatisation of banks meant a large rise in foreign presence in the domestic economies.

Consider the question “The Budget 2021-22 is characterised by its departure from the path of fiscal consolidation. Examine the theoretical basis for such departure. What are the key concerns?”

Conclusion

If the nation’s political economy came in the way of our meeting the FRBM targets, it is also likely to pose an obstacle to large-scale privatisation. A departure from fiscal orthodoxy is welcome. But the government needs to think of ways to make it more sustainable.

Back2Basics: Interest Rate Growth Differential

• • A key indicator of an economy’s long-run debt sustainability is the differential between interest paid on government debt and the economy’s nominal growth rate.
  • When the cost of raising debt is lower than the gross domestic product (GDP) growth rate, public debt comes with low fiscal costs.
  • In such a situation, the debt-to-GDP ratio of the economy declines as debts are rolled over.

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