Monday, December 26, 2011

>INDIA ECONOMICS: It’s Time to Address The Fiscal Deficit Problem

■ Fiscal stimulus played a key role in post credit crisis recovery: The government’s national fiscal deficit (central plus states combined) increased from 4.8% of GDP in F2008 to 10% in F2009. This expansionary fiscal policy has been a bigger growth driver than monetary easing over the past three years, in our view.

■ A large part of the increase since F2008 has been due to higher revenue expenditure: The government’s expenditure increase was largely centered around the revenue items wages, subsidies and national rural wage scheme. Even the capital expenditure taken up by the government tends to generate low efficiency capital asset.

■ Low productive nature of government spending brought inflation pressures: This boost to consumption via public spending helped to offset the shortfall in growth from the decline in private investment to GDP. In other words, less productive public spending substituted the decline in productive private investment. Although this approach was justified for a short period immediately post credit crisis, the government pursued this approach for too long, which meant persistent inflation pressures and higher current account deficit.

 Maintaining high fiscal deficit and pursuing monetary tightening is a sub-optimal policy outcome: Ideally, the response from the policymakers should have been a quick reversal in less productive government spending, cut in fiscal deficit to boost overall savings and at the same time initiate policy measures to boost private investments. However, a persistent delay in reversing government spending and the resultant increase in inflation pressures is forcing the Central Bank to tighten monetary policy to control aggregate demand which is only adversely affecting the growth in private investment and taking non-accelerating inflationary growth potential lower.

To read the full report: INDIA ECONOMICS