Driving Growth And Keeping Fiscal Deficit Under Control

One of the most sought after numbers in India's budget besides personal and corporate tax rate is the fiscal deficit figure.

To most investors, economists and other experts, the number sums up the health of government finances and in a way the state of the economy. Fiscal deficit is arrived at after subtracting government's total spending from its revenue earnings. The gap is funded by borrowings, and deficits accumulated over the years get counted as debt.

Over the decades, India has had large fiscal deficits as authorities strived to spend more than it expected to earn to fund basic industries, infrastructure and developmental programs aimed at generating more jobs and reducing poverty. Spending beyond one's means was then critical to lift India from the group of "least developed economies" and spread fruits of growth to a wider strata of population.

Today the country is better placed with a $2 trillion economy and growth rate that's fastest among larger economies, and ahead of the global growth dynamo China.

Yet, today there's a renewed debate on whether India should relax its fiscal deficit a wee bit and focus on pushing growth.

The Reserve Bank of India, which has painstakingly managed to rein in retail inflation to a level of its comfort, among others is not comfortable. It would rightly be the duty of the government's conscience keeper to raise a red flag if national finances go haywire. One may recall the Fiscal Responsibility and Budget Management Act (FRBM) of 2003 that set spending limits of the central government. The RBI is currently making its best to clean up the banking sector of bad loans to make a fundamental improvement.

Governor Raghuram Rajan has stressed that benefits of over-spending by the government may not be commensurate with expansion in deficit. Effects of the pay commission, one rank one pension and unscheduled spending by state governments to clean up the state electricity boards are swords hanging on accountants of both state and central government, besides their usual profligacy. The combined deficit rose to 7.2 percent as of 2015 from 7 percent in 2014.

Different Views
Proponents of higher spending say increase in government spending could boost investment cycle and push the economy into a mode of faster growth. Yet, opponents worry that over-spending may not necessarily get the returns but would surely mean increase in government borrowing and increase in interest rates. Finance minister Arun Jaitley has promised fiscal deficit of 3.9 percent of the GDP for the year ending March 2016.

Investors dread any failure by the government to defend this figure and have in the past demonstrated their discomfort by pulling out investments. Higher rates have much wider implications than the obvious ones, including pushing up the cost of borrowing for local companies and individuals.

Yet, present conditions lend support for case for wider fiscal deficit. A critical factor is absence of any large fresh investment by companies, poor credit off-take from formal banking channel, large size of stressed loans, which in turn are constraining banks from giving large fresh loans. Exports have shrunk for 13 straight months, and agriculture is pinning hopes on better rains in 2016 monsoon after two indifferent seasons.

But what about the 7.5 percent fastest growing tag? A part of the credit could go to the new GDP series that was introduced when Modi government assumed charge, and the rest on large domestic market and limited dependence on income from external markets. A large credit could also go to a global down-cycle in commodity prices that have helped companies to post healthy-looking earnings.

While everyone likes a rapidly growing economy, yet many factors holding back growth may not necessarily get addressed by simply spending more. The government must also look inwards and control its own expenses by trimming bureaucracy, among others. Its support to RBI's clean-up of bank NPAs would also go a long way into making both the banking and corporate sectors healthier. Measures such as bankruptcies law and mechanism for faster closure and sale of businesses would help the nation.

The government is in the middle of its tenure and it could just be the right time for it to clean up the system to prepare ground for rapid long term growth.