While presenting his budget this year, Finance Minister Arun Jaitley reiterated his resolve of last years’ budget, of keeping fiscal deficit limited to 3.5% of the GDP in 2016-17. It is notable that fiscal deficit has been maintained, as budgeted, at 3.9% of GDP, as per the revised estimates of 2015-16.
The endeavour of the finance minister for keeping fiscal deficit at 3.9% in 2015-16 and his decision to keep the same at 3.5% of GDP in 2016-17, is being hailed in various quarters. Call it fiscal consolidation or fiscal discipline, he is being appreciated by many, for the same. However, there are many experts who feel that it would have been prudent to raise the level of fiscal deficit. This act of finance minister could have helped him raise more resources on the one hand and helped push the growth up, in an economy facing the problem of deflation.
Fiscal deficit is defined as excess of total expenditure of government to sum of total current revenue and recovery of loans and other receipts and the same is financed by borrowing from the public including banks and financial institutions on the one hand and Reserve Bank of India (RBI) on the other.
For the year 2016-17, Rs 5.10 lakh crore of fiscal deficit has been targeted. It is notable that though the major portion of fiscal deficit is financed by barrowing from the public, still a sizeable part of it is financed by borrowing from the RBI. To provide this cushion to the central government, the RBI in turn prints more currency notes.
Main argument behind keeping the fiscal deficit low is that there is always a limit to borrowing from the public, therefore borrowing from the RBI becomes a necessity which causes expansion of money supply. As per the principles of economic theory, increase in money supply would lead to increase in price level if not matched by increase in production. Therefore, there is pressure on policy makers to keep fiscal deficit under check in order to keep inflation under control.
Though, the finance minister acknowledged that there is another view point that target to lower fiscal deficit to 3.5% of GDP, could have been postponed for concerns on growth; however, he opted to give preference to what he called ‘fiscal consolidation’.
It is worth nothing that Fiscal Responsibility and Budget Management (FRBM) Act was passed in 2003 and it was targeted that by 2008-09, fiscal deficit would be brought down to 3% of the GDP. Thus, reduction in fiscal deficit was given a statutory sanction. However, owing to the concerns of global recession, in 2008-09 fiscal deficit had actually increased to 6% of GDP, in order to raise government expenditure.
It is notable that in 2008-09, had 3% figure been adhered to, the Union budget would have been smaller in size by Rs 1,68,496 crore. Further, even in subsequent years, fiscal deficit was kept high at 6.4%, 4.9% and 5.7% during 2009-10, 2010-11 and 2011-12, respectively.
Even before the Union budget 2016-17 was presented, a debate had started that would it be prudent to cap fiscal deficit at 3.5% or the same could be increased so that the public expenditure would go up. A debate is also about the legitimacy of Fiscal Responsibility and Budget Management (FRBM) target level of fiscal deficit. It is notable that had fiscal deficit been increased to 4.2% (rather than capping it at 3.5%), the government could have got nearly Rs 84,000 crore additional, for spending.
Broad money supply
Critics argue that there is no legitimate reason to keep fiscal deficit at 3% of the GDP. While presenting his budget even Jaitley said: “There is also a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion, respectively, in the economy... I, therefore, propose to constitute a Committee to review the implementation of the FRBM Act and give its recommendations on the way forward”.
Those who suggest that there is a need to raise the level of fiscal deficit argue that credit off take from the banks is down significantly and broad money supply (commonly called M3) in India, has been falling year after year, which is resulting in loss of liquidity in the market. There has to be sufficient availability of liquidity to foster growth.
To supplement liquidity in the economy, there is a need to increase government expenditure with larger sized fiscal deficit. It is notable that there is no theoretical basis for fixing a target level of fiscal deficit at 3%. Under the circumstances, the need of the hour is to shun FRBM Act and its target level of fiscal deficit, and increase the budget size.
We see huge ups and down in fiscal deficit figures in the last 20 years. In a gap on only 2 years, fiscal deficit jumped from 2.7% of GDP in 2007-08 to 6.4% in 2009-10. In the last beg of the UPA government, efforts were made to bring down fiscal deficit. In the last budget (interim budget 2014-15) of the UPA government, then finance minister P Chidambaram gave a challenging figure of fiscal deficit at 4.1% of GDP, and this challenge was accepted by Jaitley.
However, a basic question is that whether there is any rationale of the target 3% fiscal deficit. If deficient liquidity in the economy is coming in way of growth, the government needs to give way to new thinking on the issue and raise the level of fiscal deficit. This act of the government would not only give boost to growth, but will give more money in its hands for sectors like health and education.
(The writer is Associate Professor, PGDAV College, University of Delhi)