Adhering To Fiscal Deficit Target

iasparliament
October 17, 2017
1 month
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What is the issue?

  • India is witnessing a sharp deceleration in economic growth.
  • Fiscal stimulus is being touted as a policy measure to revive the economy.
  • However, a deeper understanding in terms of 'fiscal deficit' reveals why fiscal stimulus is not the right option.

Why a slowdown in economy?

  • There were many transient factors like the GST and demonetisation impacts for the current slowdown.
  • But besides these, one of the prime reasons is the steady and sharp decline in the investment rate.
  • Notably, public investment in recent years has shown a small rise.
  • So the lowering investment rate has largely been due to the decline in the private investment rate.
  • The Gross Fixed Capital Formation (GFCF) rate has come down in the recent quarter.

Why not a fiscal stimulus?

  • A fiscal stimulus is one in which the government spends more from its own pocket or slashes tax rates to boost a sluggish economy.
  • This results in more money in the hands of consumers, and as a result spending goes up, thereby encouraging demand and growth.
  • There are opinions that a strong fiscal stimulus through an increase in public investment and a relaxation on the fiscal deficit obligation is needed.
  • However, an understanding of the real factor behind slowdown as said above, demands policy initiatives for raising the private investment.

Why is relaxing fiscal deficit target risky?

  • Borrowing space - The prime focus of fiscal deficit targeting is to ensure that the private sector has sufficient borrowing space.
  • Increasing government debt and increasing interest rates reduces the credit available for businesses.
  • Also, government selling its securities, such as Treasury bonds to finance its debt absorbs the available funds from the private sector.
  • So, widening fiscal deficit would only narrow the borrowing space and reduce private investment at a time when it has to be boosted.
  • Debt-GDP ratio - Government has set a target of debt-GDP ratio at 60% in 2023 from the present level of 70% .
  • This requires the Centre and States to contain their debt-GDP ratios at 40% and 20%, respectively.
  • This is achievable only by limiting the fiscal deficit at 3% of GDP in the first three years and 2.5% in the next two years by the Centre and States.
  • Revenue deficit - Over 60% of the estimated fiscal deficit at the Centre in 2017-18 (1.9% out of 3.2%) is revenue deficit.
  • At the State level also , the revenue deficit is only expected to increase.
  • This is because of the impact of loan waivers, additional interest payments on account of UDAY scheme, and pay revision as per 7th pay commission.
  • Given all these, any additional fiscal stimulus measures would only widen the already increasing revenue deficit.

What lies ahead?

  • India's economic history is replete with adverse effects of fiscal expansion on inflation as well as the balance of payments.
  • The huge fiscal expansion in the late 1980s and 2008-09 have led to some serious economic crisis besides the benefits.
  • Clearly, the solution to the current slowdown in growth lies in:
  1. reviving private investment.
  2. recapitalising banks to enable them to lend more.
  3. speedy completion of stalled projects.
  • The fiscal deficit rules evolved are consistent with the level of savings and the demands of the various sectors on those savings.
  • So, fiscal prudence is crucial for sustaining growth over an extended period.
  • In this challenging economic situation, any aggressive attempt to widen the fiscal deficit would only worsen India’s economic problems.

Quick Facts

Fiscal Deficit

  • Fiscal deficit is the difference between total revenue and total expenditure of the government.
  • It is an indication of the total borrowings needed by the government (so as to finance the deficit).
  • Fiscal deficit takes place either due to revenue deficit or a major hike in capital expenditure.

Gross Fixed Capital Formation (GFCF)

  • Gross fixed capital formation is essentially the net investment.
  • GFCF refers to the net increase in physical assets (investment minus disposals) within the measurement period. 
  • It does not account for the consumption (depreciation) of fixed capital, and also does not include land purchases.
  • It is a component of the Expenditure method of calculating GDP and measures the net increase in fixed capital.

 

Source: The Hindu

1 comments
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PP 1 month

Presented  a simple issue in simplest form from a very complicated editorial text. I loved it. Thank you. 


I have ONE doubt though,

I usnderstood from the editorial that - Fiscal stimulus is not the key, as culprits are private investers. But, Can anyone explain how exactly it (fiscal stimulus) will narrow down the borrowing space of private sector?

what i see is, fiscal stimulus -> more money in market -> more demand -> more supply -> rcovery..

so how it will narrow down the borrowing space, its just - private players are sidetracked here!



IAS Parliament 26 days

1. Fiscal stimulus -> more money in market -> more demand -> more supply -> recovery....is right. • However the point here is “how sustainable can fiscal stimulus a solution be???” • Fiscal stimulus could boost the economy temporarily, but increasing fiscal deficit would pull down growth in the longer term. • The prospects for economic growth once the stimulus wears off is also uncertain.

IAS Parliament 26 days

2. Fiscal deficit is an indication of the total borrowings needed by the government (so as to finance the deficit). • Clearly, increasing fiscal deficit would later on necessitate the government to borrow more. • Government, by selling its securities, such as Treasury bonds to finance its debt, will absorb the available funds. Hence the borrowing space for private players get narrowed down • Given all these private players get crowded out. • Since low private investment rate is a major reason for the current slowdown, this could become unfavourable for a healthy economy.

PP 22 days

Awesome! Got it! Its just

IAS Parliament 20 days

Thank you. Keep Reading

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