FINANCIAL SCENE
Balancing the short and medium term goals
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The government will have to consciously decide on new fiscal stimulus packages
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The centre will continue to juggle with two different objectives — allocating more resources for social sectors and fiscal consolidation over the medium term.
— PHOTO: SHANKER CHAKRAVARTY
COMMITTED TO GROWTH: Union Finance Minister Pranab Mukherjee addressing his first press conference after assuming charge.
Finance Minister Pranab Mukherjee, in one of his first interactions with the media after formation of the UPA government, has said that his government is unambiguously committed to restoring growth and employment and that “would not be possible without increased spending funded by incremental borrowing”.
However, the government is equally committed to the process of fiscal consolidation over a period of 2 to 3 years. The Finance Minister has touched upon a major dilemma that his government faces in the area of public finance.
It may be necessary for the government to spend more to boost the economy. In all probability this will increase the fiscal deficit. However, if, as it is hoped, the government’s action spurs growth, its revenues will improve and the fiscal deficits will become manageable.
Large borrowing
On the other hand, the government will have to borrow more and that will stand in the way of lower interest rates. The cost of government as well as private sector borrowings will go up. As the RBI Governor put it: “Large borrowings by the government run against the low interest rate environment that the RBI is maintaining to spur investment demand.”
Only through fiscal consolidation can this vicious circle be broken up. In short, there is a trade off between the short-term objective of stimulating growth and the medium term objective of fiscal consolidation. It is going to be a major challenge for the government to manage this trade off.
Just a few days earlier, RBI Governor D. Subbarao had expressed this fiscal dilemma in a slightly different way. Pointing out that economic recovery can be sustained only by practising financial rectitude, he urged the government to undertake fiscal consolidation over the near term.
The Union budget for 2009-10 due to be presented (according to the latest reports ) in early July will provide important clues to the way the new government looks at its finances but even in these early days after Cabinet formation it is clear that the following will receive the government’s attention.
First, the economy, though not on a downward spiral, may still require fiscal stimulus packages to boost demand. Besides, India’s infrastructure deficiencies are well documented and no budget exercise can ignore them. Certain sectors such as textiles, badly hit by the global recession, cry out for public support. In the run up to the budget many other sectors/industries will join the race for government handouts.
Second, the deteriorating state of government finance does not allow any delay in planning a programme of fiscal rectitude.
Last, there is the pressing issue of reforms including financial sector reform.
The government will have to consciously decide on new fiscal stimulus packages without undermining the already weakened fiscal situation. The UPA Government appears to have scored major gains in the elections on the basis of its track record in conceiving and implementing social sector schemes such as the National Rural Employment Guarantee Scheme. That being the almost universal belief, the new government is likely to go slow on such schemes. Whether the extra spending will be in the form of stimulus packages or as normal budgetary spending towards expanding the scope of these schemes or the infrastructure sector is immaterial as far as government finances go. The Finance Minister has said that increased spending will continue well into 2009-10.
Strained finances
The interim budget had pointed to a deterioration of government finances. For 2008-09 the estimated revenue and fiscal deficits at 4.4 per cent and 6 per cent were sharply higher than the budgeted 1 and 2.5 per cent, respectively. The consolidated fiscal deficit of the Centre and the States including the off-budget items is estimated to be above 11 per cent of the GDP. The RBI’s concern over high government borrowings is genuine. It is true that inflationary pressures can be contained because of the existence of excess capacities in many sectors. However, large public borrowings will be inflationary and will also crowd out private investments.
The measures that merit attention in coming months include considerable improvement in delivery of public services, ensuring greater accountability, efficient targeting of expenditure, weeding out wasteful expenditure and constant monitoring. All these are not new and have been prescribed by even international agencies for a long time.
However, they remain significant especially when the government tries to reconcile the short-term goals with the long-term ones.
C. R. L. NARASIMHAN
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