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Business News/ Opinion / Saying goodbye to sound public finance
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Saying goodbye to sound public finance

Fiscal expansion as a route to growth is, historically, a bad idea in India

Any fiscal expansion will defeat the hard-won fight against inflation, the product of tight monetary policy over the years. Illustration: Shyamal Banerjee/MintPremium
Any fiscal expansion will defeat the hard-won fight against inflation, the product of tight monetary policy over the years. Illustration: Shyamal Banerjee/Mint

When finance minister Arun Jaitley presented the national budget in July, it disappointed many for its lack of direction. At that time, euphoria about the new government led to postponement of doubts for a while. That period may be ending now.

The Mid-Year Economic Analysis, issued by the finance ministry on Saturday, makes it clear where the priorities of this government lie. Reading the report three points are clear. One, this government believes that India can afford a fiscal expansion now. Two, public sector investment is likely to be the preferred mode of investment for growth. Three, the resources for investment can be found by switching the structure of spending from subsidies to capacity expansion. In three successive paragraphs—1.49 to 1.51 (page 18)—the report demolishes the consensus on sound public finance in India. It is clear that this is a government in a hurry.

The path ahead may be sketched roughly this way. There will be fiscal slippage on the way but in a low-inflation environment coupled with low global prices of key commodities, India can afford fiscal expansion. “A case not just for counter-cyclical but counter-structural fiscal policy, motivated by reviving medium-term investment and growth, may need to be actively considered (page 18)."

Excuses have already been readied for fiscal slippage. The mid-year review notes, “Therefore, evaluating the fiscal performance this year should take account of the legacy costs and the ambitious targets that were inherited. They were ambitious because of optimistic revenue projections, of unanticipated moderation in inflation (the consumer’s gain being the government’s loss), and also because of below-potential growth (page5)."

Three objections can be raised straightaway to this path. One, any fiscal expansion will defeat the hard-won fight against inflation, the product of tight monetary policy over the years. One reason why the central bank refused to reduce policy rates was the last government’s unwillingness to effect credible fiscal consolidation. This government is out to follow the path of its predecessor with a vengeance.

Two, its belief in reducing a spectrum of subsides—fuel, food, fertilizer, power, etc.—by using instruments such as Aadhaar unique identity number is touching. Apart from well-known problems in rolling out the direct benefits programme on a significant scale, it defies belief that a political economy of patronage and spending can be undone overnight. Similar hopes have been placed on the goods and services tax (GST) help create the fiscal space required for investment spending. The GST is not a law and it is unlikely to be implemented in a form that will create what this government wants anytime before two years.

Three, the government’s faith in the public sector is misplaced. It is true that public-private partnerships have not worked as they were imagined. The private sector under-appreciated risks, cost over-runs and slow regulatory clearances slowed infrastructure to a crawl. But does that mean the public sector can take over where the private sector left virtually overnight?

The last point shows a wider dissonance that may plague this government in the months and years ahead. On the one hand, it displays an alarming indifference between private and public sectors when it comes to investment, disregarding the historical experience of the latter’s poor performance in India. On the other hand, it continued to believe in divestment. Unless, of course, the latter is merely for the consumption of ratings agencies and citizens.

There is a political economy of hurry at work here. One reason for the overwhelming political mandate given to the lead party of this government was restoring India’s economic momentum. It is a problem of managing expectations. Sound macroeconomic management should not be sacrificed for that. The reasons due to which economic growth petered out ultimately were a combination of huge expenditures and policy paralysis. Ending policy paralysis and continuing with huge spending will not end India’s growth impasse.

The attitude of this government can be summed in a single line: growth at any cost. At any cost is usually a bad idea.

Can the government spend its way to higher growth? Tell us at views@livemint.com

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Published: 21 Dec 2014, 07:31 PM IST
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