In the recently presented budget, India’s fiscal deficit for FY 2017-18 got revised upwards from 3.2% to 3.5% of GDP and the target fiscal deficit for FY 2018-19 is set at 3.3%. Though Moody’s has said that a slight slippage in fiscal deficit has no material impact on overall economic strength, Indian rupee slide past 64 post budget and bond yields hardened substantially. This begs a question that Shouldn’t the government have some space to operate its fiscal policy? I argue that the stringency we are placing on the path of fiscal consolidation makes us anti-Keynesian and I believe that that’s not optimal.
The first subtle and grossly unappreciated point is that expressing the fiscal target as a percentage of GDP makes our policy Pro-Cyclical or Anti-Keynesian. Fiscal deficit expressed as a percentage of nominal GDP can be breached even if expenditure in Rupee term is adhered to but the actual GDP falls short of forecast GDP based upon which government plans its budgetary expenditure. To achieve the fiscal deficit target as a percentage of GDP requires that government literally scales back the Rupee expenditure when economic growth slows down. Is this a desirable fiscal policy? No so much! That is what the evidence suggests so.
Greece is a leading example of what austerity measures could do to the country’s economic growth. Greece lost 30% of the GDP since 2010 after imposing the austerity measures. In fact, as IMF’s recent paper suggests that countries who employed severe austerity plans lost more in terms of GDP growth post-financial crises. (See Figure 1) When Canada employed massive fiscal consolidation in 1997-98, it was running a 4% plus GDP growth rate (which is very high for an advanced economy) and more importantly had high-interest rates. Bank of Canada could counter some of the negative impacts of austerity by reducing the interest rates. In India, where inflation is sitting right in the middle of inflation target band and where RBI has limited scope to tinker with the rates, fiscal austerity would have a much higher bite in India. Even generally, history suggests that countries have resorted to counter-cyclical policies. For example, take USA’s case. IMF has made available fiscal data from 1800 for the USA. The USA experienced a fiscal deficit of 30 basis points higher on average during worst 30 years in last two centuries compared with best 30 years.
Let’s flip the side and ask if being-Keynesian helps. 2011 paper by Auerbach and Gorodnichenko in American Economic Review and a follow-up paper by Valerie Ramey and Sarah Zubairey both convincingly show that at least in the USA, fiscal multiplies in bad times are large; meaning that government expenditure helps during bad times. Richard Koo’s hypothesis also suggests that when everyone in the private sector is deleveraging their balance sheets, the government should not do so as it will reduce the aggregate demand. In short, evidence supports the being Keynesian in bad times. But Auerbach in his 2011 paper also shows that fiscal multiplies can be close to zero or even negative during good times. This can occur because the government can crowd out private borrowers from credit markets by putting upward pressure on the interest rates. This implies that it's important that government stick to counter-cyclical policies all the times.
The fear most economists have is exactly this that counter-cyclical policies hardly stay counter-cyclical by the time economy enters the boom phase. At that time governments find it tough to control the spending amidst high tax revenues and golden opportunity to move towards fiscal balance can be lost. But does India’s case look like that? Since 1990, India has been able to maintain fiscal in a broad range of 2%-4%, even after undergoing a wave of productive capital expenditure during NDA government at the turn of the century. More recently, we had a very high fiscal deficit in 2009 of roughly 9%. UPA pulled it back to 4.4% till 2014. But they also had good growth years to support fiscal consolidation. From 2014, the BJP-led government has been able to reduce the fiscal deficit further to 3.2%-3.5% range even after having sub-7% growth years. I feel that Indian governments have shown fiscal record which is credible enough to allow them some flexibility to counter the slow growth.
Observers got a bit worried that fiscal slippage was lead by the revenue deficit rising to 2.6% compared to the planned 1.9%. But many of the government expenditures on education, health, and rural programs are categorized as revenue and to call it wasteful is not really correct.
In summary, I propose that government should have a long-term plan for achieving fiscal balance. But the glide path should really be a function of the state of the economy that prevails in the future. It should allow for overshooting during tough times but requires undershooting during good times. After all, being Keynesian is not being fiscally imprudent.
Dr. Apoorva Javadekar
05/02/2018
