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Following is the Summary of ECONOMIC SURVEY 2016-17 – Chapter – 5 Fiscal Framework: The World is Changing, Should India Change Too?
Introduction
Since the government came to power, there has been a steadfast commitment to fiscal consolidation, reflected in the steady decline in the fiscal deficit from 4.5 percent of GDP in 2013-14 to 4.1 percent, 3.9 percent, and 3.5 percent over the successive three years.
The trend of the recent time shows that monetary easing has run its course, attention has increasingly turned to the role of fiscal policy.
But there has been a shift in the conventional understanding over use of fiscal policy articulated most clearly recently by Jason Furman of President Obama’s Council of Economic Advisers1, comprises the following:-
- Fiscal policy can legitimately be used for counter-cyclical policy.
- It is particularly effective when monetary policy is at the zero lower bound, because at that point multipliers are large, close to 1.5
- And because fiscal policy is effective in increasing GDP, it will lead to significant increases in tax revenue, meaning that fiscal activism can partly pay for itself
- In any event, estimates of sustainable debt levels should be revised upwards, because interest rates will remain low.
What is counter cyclical policy?
A ‘countercyclical’ fiscal policy refers to the opposite approach: reducing spending and raising taxes during a boom period, and increasing spending/cutting taxes during a recession.
The case for activist fiscal policy in the advanced economies (AEs) rests ultimately on two pillars:
- Weak economic activity
- And the inability to address this problem through monetary policy.
Does India need a fiscal activism?
India’s situation differs from that of the advanced economies (AEs) in some important ways.
Indian growth rates are substantially higher, while inflation rates are also substantially greater, reducing the need for fiscal activism.
Because inflation is already relatively high, counter-cyclical policy has to be much more sensitive to triggering higher inflation.
2 previous experiences are useful as counter arguments against use of countercyclical fiscal policies:-
- In the early 1980s, there was an expansion in spending and deficits in response to accelerating growth. The inability to rein in these deficits played a key role in undermining India’s external situation, which led to the balance of payments crisis of 1991.
- In other case, boom-financed spending since 2005-06 combined with the sharp stimulus 4 percent of GDP in the wake of the Global Financial Crisis, which was then not withdrawn adequately or on time, led to the financial-currency “near-crisis” in the autumn of 2013.
In other words, India’s fiscal stance has an in-built bias toward higher deficits, because spending rises pro-cyclically during growth surges, while revenue and spending are deployed counter-cyclically during slowdowns. This pattern creates fiscal fragility.
Fiscal rules, insofar as they can be effective and binding, must therefore aim to prevent spending surges during booms and constrain counter-cyclicality during downturns.
India and the World: Stocks
India also appears to have a stock problem, in that its debt-to-GDP ratio is higher than many other emerging markets. But such a mechanical comparison is not an appropriate way of assessing India’s fiscal strength: the true problem is much more subtle.
1.Fiscal commitment
India shares with advanced economies the experience of not having defaulted on its domestic debt either de jure or de facto (through long periods of high inflation).
In the recent past, India’s highest level of debt has been 83 percent of GDP and it has made sure that its debt service obligations have been conscientiously met.
When doubts about India’s ability to meet its debt service obligations to foreign creditors arose in 1991, the government took extreme measure like pledging gold to reassure creditors that it had no intention to default.
2.Debt dynamics
A government is running a primary deficit, pd, then nominal growth must exceed the nominal interest rate ([g – r] must be positive) to keep debt from increasing. In contrast, if the primary balance is positive, then debt ratios can remain steady even if [g – r] turns negative.
This vulnerability in India is the country’s primary deficit, i.e. the shortfall between its receipts and its non-interest expenditures. Put simply, India’s government (centre and states combined) is not collecting enough revenue to cover its running costs, let alone the interest on its debt obligations.
There is nothing extraordinary about running a primary deficit, per se. Most of the other large emerging markets do so after Global Financial Crisis. But at such rapid rates of growth, substantially greater than those of its peers, India’s primary deficit should have been much lower than others; instead it has been significantly greater.
Conclusion
- Back in 2003 there was common agreement that fiscal policy should be aimed at medium-term objectives such as reducing the stock of debt rather than shorter-term cyclical considerations.
- Now, advanced countries have moved away from these principles toward greater fiscal activism, giving counter-cyclical policies much more of a role and giving correspondingly less weight toward curbing the debt stock.
- But India’s experience has reaffirmed the need for rules to contain fiscal deficit because of the proclivity to spend during booms and undertake stimulus during downturns.
- It has also highlighted the danger of relying on rapid growth rather than steady and gradual fiscal and primary balance adjustment to do the “heavy lifting” on debt reduction.
- In short, it has underscored the fundamental validity of the fiscal policy principles set out in the FRBM.
- But the operational framework of FRBM designed in 2003 will need to be modified to reflect the India of today, and even more importantly the India of tomorrow. This, then, will be the task of the FRBM Review Committee.
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