Tuesday, 31 January 2017

Much ado about fiscal deficit

A Budget that spurs demand is the need of the hour. The view that fiscal stimulus crowds out private spending is questionable


Whatever may be the actual recommendations of the NK Singh panel tasked to review the fiscal consolidation roadmap, it has been widely agreed, by now, that the upcoming Budget should focus on stimulus measures in order to boost domestic demand, improve investments and pave the way for job-filled growth.

Demonetisation is behind us and the withdrawal of cash has led to temporary problems of demand compression with consequential impact on growth. But, if there is something akin to the balance sheet of the economy, it can be seen that this is indeed the moment for a path-breaking Budget that can induce a sharp recovery.

The balance sheet
Budgets refer to income and expenditure statements. But there is very little discussion around the major elements of what could be construed to constitute the country’s balance sheet. The UN has been bringing out the Inclusive Wealth Report (an exercise which broadly looks at “manufactured capital, human capital, natural capital and social capital” as a country’s assets and internal and external debt of the government and private entities as liabilities) which had attempted to marry essentially an accountant’s perspective with that of an economist.

If one were to take just the liabilities from this ‘balance sheet’, it would emerge that the country is perhaps at an economic sweet-spot from where a jumpstart is possible. Let us take external debt first. According to the latest report of the Ministry of Finance, India’s external debt stock stood at $485.6 billion at end-March 2016 as against $475.0 billion at end-March 2015. While external debt has increased over 2015-16 by a small 2.2 per cent, important debt indicators such as external debt-GDP ratio and debt service ratio remain comfortable.

Our external debt continues to be dominated by long-term borrowings. The external debt policy pursued by the Government has kept external debt within manageable limits. India continues to be among the less vulnerable countries with its external debt indicators comparing well with other indebted developing countries, as the survey states. Of this debt, what is significant is that government debt is only $93 billion in India’s case.

Further, the ratio of short-term debt on the external front is a modest 18.5 per cent which means that there is no reason for any anxiety on the debt-servicing front, at least for the next year. Just for comparison purposes, it may be noted that China’s share of short-term debt is 71.2 per cent though that is mitigated by its very high reserves position.

Government debt
As for short-term government debt, it stands at a measly $108 million, indicating that concern on the external debt front, as of now at least, is unwarranted. Our foreign exchange reserves are at $359 billion.

When it comes to total government debt, the figure is ₹60, 33,464 crore including external debt. To give an idea of the indebtedness of the country, it would be useful to compare this with the total credit/ loans taken by all domestic entities inside India from the banking system — it stands at about ₹76,00,000 crore. And one major difference has been that whereas the Government has been borrowing at fixed rates, all others are borrowing at floating rates.

So, in a falling interest rate regime, the Government has been effectively paying higher interest!

Our share of government debt to GDP is at about 70 per cent and there are countries in the Euro Zone which have these ratios closer to about 90 per cent. Of course, the percentages in the case of Japan, the UK and the US are much higher.

The obsession with fiscal deficit is premised on two grounds, mainly. One, that budget surpluses are a form of national saving, and two, that higher fiscal deficits would crowd out private investments because of the pressure it would put on interest rates.

There have been studies and reports which have negated both theses empirically. One of them, based on RBI data, conclusively stated that there is no significant relationship between high fiscal deficits and high interest rates.

Anecdotal evidence is also now on hand; banks have invested more in government debt than the SLR requirement and still have liquid surplus to lend, which has forced them to drop rates. At present, a 10-year government security has a yield of 6.7 per cent, much lower than a one-year bank deposit rate.


Much of what can be called “fiscal deficit fundamentalism” can be attributed to neo-classical views which would fit western liberal economies. Thanks to our inclination to save (net savings rate is about 31 per cent of GDP), government borrowing, per se, need not be seen as a matter of concern.

Fiscal fundamentalism
Of course, like any other economic entity, our government also cannot perennially borrow and live beyond its means. But to cling to numeric targets even when the crying need of the hour is to boost demand and public investments (so that it will crowd in private sector investments) would be detrimental to the growth trajectory that we need to have to generate enough jobs.

Also, when monetary policy is seemingly constrained by exchange rate considerations, fiscal fundamentalism may have to be abandoned.

Putting money in the hands of the poor and the middle classes, making life easier for the distressed farm sector and making for vibrancy in the small and medium businesses is vital.

The country’s economic balance sheet seems strong and resilient enough to afford the Government ‘space’ to be accommodative enough to spur growth impulses, without going overboard on fiscal loosening.

The writer is with the State Bank group. The views are personal

Share it!