Fiscal Consolidation has Begun too Soon : Daily Current Affairs

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment; Government Budgeting.

Key phrases: National Income, Medium-term growth, capital intensive, revenue expenditure, MGNREGA, fiscal consolidation, Fiscal Responsibility and Budget Management (FRBM) Act, 2003, credit rating agencies.

Why in News?

The Centre seems to be worried about sovereign ratings. The Budget started tapering off the expansionary fiscal policy prematurely and focused on fiscal compliance for fear of sovereign downgrading by the global CRAs. Social sector schemes deserved more funds in the Budget.

Context:

The Finance Minister, in her Budget speech, emphasised India’s strong resilience during the pandemic as the economy bounced back to pre-pandemic levels of GDP. India lost two years of GDP due to the pandemic. Meanwhile, the Ukraine conflict has added to prevailing uncertainties.
The NSO in its latest national income estimate for 2021-22, has downsized growth from 9.2 per cent to 8.9 per cent, compared to the 6.6 per cent contraction in 2020-21.
The recovery from the pandemic has been unequal as a large number of small and micro enterprises have been struggling to recover. Though the aggregate unemployment rates came down to the pre-pandemic level by September 2020, a disaggregated analysis of CMIE CPHS (Consumer Pyramids Households Survey) data shows a disproportionate impact of the pandemic on the employment and income of women, youth, and people belonging to marginalised communities. The government’s fiscal strategy is crucial for the direction of the post-Covid inclusive recovery process.

Medium-term growth strategy

From the perspective of medium-term growth strategy, the attempts to boost capex are laudable as it is expected to crowd-in private investment and create large multiplier effects. And this is expected to create jobs and boost aggregate demand.
However, given the capital intensive nature of large-scale infrastructure projects, massive employment generation is unlikely. Further, there is a huge gestation period. Thus, the actual multiplier effects may be smaller than assumed by the Budget.
The government has increased capex at the cost of revenue expenditure. Compared to FY22RE allocation, total spending and revenue expenditure have fallen in real terms after adjusting for inflationary expectations in FY23. As the economy is recovering from Covid 19, a higher revenue expenditure was expected since it has a higher multiplier effect in the short run and helps the economy recover faster than capex. It will also have an ameliorative impact.

No demand-augmentation

The latest estimates for 2021-22 released by the NSO show that private final consumption expenditure — accounting for about 60 per cent of GDP — is back to pre-pandemic levels. However, some studies show that the bottom 40 per cent population experienced a more significant decline in income, and the recovery has been weak, resulting in increased inequalities. Analysis of CPHS data shows that not only does the consumption of marginalised groups and bottom sections decline faster, their recovery has been slow while the consumption of non-rich returned to pre-pandemic levels after the initial lockdown.
Hence, social sector spending is critical for households pushed below the poverty line. When total revenue expenditure is netted of committed expenditures (interest payment increased by 15.6 per cent and pension by 4.1 per cent), nominal social sector spending is drastically reduced. The programmes that bore the maximum brunt of the fiscal consolidation are food subsidy and MGNREGA.
In contrast, allocations for urban development, transport, IT and telecom increased considerably, which could aggravate the rural-urban divide. As the urban areas lost more employment during the pandemic, an urban employment guarantee programme would assure income for the unemployed and help boost consumption demand.

Premature fiscal consolidation

The Union government’s mistimed focus on fiscal consolidation is hugely responsible for trimming the revenue expenditure. While revised estimates of revenue expenditure overshoot Budget estimates, revenue deficit declined from 5.1 per cent (FY22BE) to 4.7 per cent of GDP (FY22RE).
The rise in direct tax collection and GST collection could have been utilised in social sector projects. Instead, the Finance Minister preferred to stick to the fiscal consolidation path and bring down the fiscal deficit from 6.9 per cent (FY22RE) to 6.4 per cent (FY23BE). This fiscal consolidation in times of crisis delays the inclusive recovery process.
Despite the rise in tax collections and marginal reduction of total expenditure, the union government debt, both internal and external, is projected to rise from 52.7 per cent in FY22RE to 59 per cent of GDP (FY23BE). In normal times, this would be considered significant and worrisome. However, due to countercyclical fiscal policy measures, governments across the world resorted to debt financing of fiscal stimulus measures, which resulted in an all-time high of $226 trillion global debt, taking the debt-GDP ratio to the highest point after the Second World War.
Why is fiscal consolidation important for an emerging economy?
Fiscal consolidation refers to the ways and means of narrowing the fiscal deficit. A government typically borrows to bridge the deficit. It will then have to allocate a part of its earnings to service the debt. The interest burden will increase as the debt increases. In the Budget for FY22, of the total government expenditure of over ₹34.83 lakh crore, more than 8.09 lakh crore (around 20 per cent) went towards interest payment. Debt is one liability that is difficult to defer and, at the end of day, the government struggles to find more resources not just for capital expenditure but also revenue expenditure. In the long run, uncontrolled fiscal deficit will hurt economic growth.

Is fiscal consolidation legally mandated in India?

The seeds for fiscal consolidation were sown in 1994 by the then Finance Minister Manmohan Singh. In his budget speech for FY95, he highlighted the need for fiscal discipline and pronounced a policy to end monetising the deficit. Till then the government was financing its deficit by creating money, through unlimited recourse to the Reserve Bank, by issuing ad hoc treasury bills. This weakened the Reserve Bank’s ability to direct effective monetary policy. Singh announced phasing out ad hoc treasury bills, after which the government would fund its deficit through market borrowings.
As open market borrowings piled up to fund the deficit, Yashwant Sinha in his budget speech for FY01 called for a strong institutional framework to ensure fiscal responsibility. This resulted in the enactment of the ‘Fiscal Responsibility and Budget Management (FRBM) Act, 2003’, which mandated limiting the fiscal deficit to 3 per cent of GDP.

Way Forward:

More importantly, the weight of available empirical research suggests that higher debt does not necessarily lead to lower growth. A higher debt/GDP ratio can stimulate aggregate demand and output in the short run. And this is what the Indian economy needs now. International experience suggests that countries that borrowed to finance their fiscal spending have been able to recover from the pandemic faster.
Further, recent research shows that borrowing does not adversely affect the economy as long as the government follows a credible fiscal policy plan that reduces the debt burden back to sustainable levels. Hence, it is important that the government invests substantially not only in building infrastructure for growth but also focuses on targeted short-term measures that boost the consumption demand of those worst hit by the pandemic.
The fiscal consolidation path of the government could be driven by fear of sovereign downgrading by the global credit rating agencies (CRAs). However, last year's Economic Survey demonstrated that economic fundamentals do not justify or drive sovereign credit ratings. Research suggests that CRAs give higher ratings to developed countries regardless of their fundamentals.
The Budget started tapering off the expansionary fiscal policy prematurely and focused on fiscal compliance for fear of sovereign downgrading by the global CRAs.
The ongoing Russia -Ukraine war has disrupted supply chains and pushed energy and commodity prices. As costs rise and interest rates rise, capital expenditure will slow down. A higher allocation towards revenue expenditure, particularly flagship social sector programmes would have sustained the economic revival. One can only hope that the government’s strategy does not cost the Indian household in a big way.

Source: The Hindu BL

Mains Question:

Q. What do you understand by Fiscal Consolidation? Is there is a need to balance between Fiscal consolidation and fiscal expansion to recover from the pandemic faster. Critically Examine the Examine.