Fiscal Activism / fiscal consolidation

 The flailing Indian economy, affected by the Covid-19 pandemic, is characterized by a contraction of GDP that needs a government drive. The government has resorted to Keynesian economics (government spending rather than the free hand of the market) in this situation.

A selective departure from the values of the free market is the 2021 Budget. The government adheres to elements of market ideology, such as privatization and a greater position for foreign direct investment, but has tried to spend more to boost growth.

The fact that the Finance Minister's speech aims to reduce the fiscal deficit to 4.5% of GDP by 2025-26 and promises to bring an amendment to the FRBM Act to formalize the new goals can be reflected in this (the present target as per the FRBM Act is of 3 percent ).

The budget thus represents a major break from one of the main tenets of the Washington Consensus, the market-oriented economic system that has dominated policy-making in most parts of the globe. While this is a step in the right direction, there are some key questions regarding macroeconomic stability.

Departure from Free-Market Economics principles

§ Budget 2021 is focused on six pillars: health and well-being, physical and financial resources and infrastructure, aspirational India inclusive growth, human capital revitalization, innovation and R&D, and minimum government-maximum governance.

§ This would entail substantial funding increases, not just from the central government, but also from the states and the private sector. This could be reflected in some of the budget's following highlights:

·         A whopping 34.5 percent rise in budget allocation is present in the current budget. Rs 5.54 lakh crore.

·         A new bad bank structure has been suggested by the Budget to deal with the question of non-performing assets. A massive amount of capital would be needed to fund it, considering the size of the NPA.

·         The government has also announced the establishment of a development finance institution to provide infrastructure projects with long-term financing.

IMF & World Bank Endorsed Idea

·     In the aftermath of the pandemic, the International Monetary Fund (IMF) and the World Bank, both flag-bearers of the Washington Consensus, urged a break from fiscal orthodoxy.

·     Both of these organizations used to be wary of any rise in the ratio of public debt to GDP above 100%.

·     Today, even though the debt-to-GDP ratio is poised to grow to 125 percent by the end of 2021, they urge industrialized economies to invest more by running up deficits.

Main Problems for Macroeconomic Stability

Inflation Might Rise: There is concern that inflation will rise due to a large fiscal deficit.

·         Moreover, a change in the fiscal consolidation goals is more than likely to entail a 4 percent change in the inflation target set by India's Reserve Bank. The Budget, however, makes no mention of such a possibility.

Low tax-to-GDP ratio: Another issue is that, with the tax-to-GDP ratio not increasing as planned, through strategic disinvestment, privatization, and monetization of non-core properties, the government must concentrate on raising more non-tax revenues.

·         These measures, however, have their own problems.

Disinvestment, a high-risk strategy: In the years ahead, sales of public assets have become essential for reducing fiscal deficits. This is a high-risk approach, however.

·         Revenues from disinvestment have fallen short of goals for years now. For instance, the sales of Air India, which started in 2018, are still dragging on.

·         Moreover, because of public sector unions and job cuts, selling public assets is politically controversial.

Downgrade of ratings: A significant factor is the concern that if total public debt crossed, India will be downgraded by the rating agencies, say, 10 percent-11 percent of GDP.

Conflict with AtmaNirbharta: In addition, substantial FDI is almost always involved in large-scale privatization. Rising FDI would result in a significant increase in the domestic economies' international presence.

·         A rise in FDI, however, may not be consistent with Atmanirbhar Bharat, which implies greater self-reliance and stronger Indian firms.

Crowding Out Effect: As an expansionary fiscal policy posture is adopted by the government and its spending is increased to improve economic activity.

·         This will lead to a rise in interest rates. Private investment decisions are influenced by increased interest rates.

·         The high magnitude of the crowding-out impact can also result in lower economic revenues.

Conclusion-

A deviation is welcome from fiscal orthodoxy. But to make it more viable, the government needs to think of ways.