The Hindu Business Line : Why the effects of fiscal deficit are not visible

The Government will have to reduce its revenue deficit if India is to move towards the 10 per cent growth rate mark. At present, India is using the energies unleashed by institutional reforms to support revenue deficit and government consumption.

"THE beauty of India's fiscal deficit is that somehow the consequences of the lack of fiscal prudence are not showing up," says the IMF Chief Economist, Dr Raghuram Rajan. The question is why this may be so. According to the RBI's Annual Report, the present fiscal deficit is about 5 per cent of GDP while the average of the last 10 years has been 4.4 per cent. But inflation is in control at a mere 5 per cent. Interest rates also remain at historic lows. On the flip side, however, economic growth has been languishing for five years at 5.6 per cent against 6.2 per cent in the late 1980s.

Though the estimate for the present year is at 8 per cent, it is too early to consider it stable. It owes itself substantially to such extraneous circumstances as good monsoons and decline of the dollar. Why are inflation and interest rates low despite the high fiscal deficit in the last five years?

The Government is borrowing from the market to meet its fiscal deficit instead of asking the RBI to loosen its monetary stance. Thus, there is low inflation despite high fiscal deficit. But the interest rates should have risen with the Government resorting to heavy borrowing. Why is this not happening? It has been pointed out previously that the growth rate has been low in the last five years.

The low rate of investment in the economy has contributed to low growth rates. According to the Economic Survey of that year India was investing 22.1 per cent of its income during the first reform five reform years, 1992-97. This declined to 21.7 per cent in the last five years. The demand for money in the market is low because of this decline in investment. The lag left by less borrowing for investment has been absorbed by government borrowing for consumption. Hence, the interest rates do not rise. The same decline in investment has led to low growth rates. Had the Government borrowed for investing in such projects as the Golden Quadrilateral or interlinking of rivers, such a decline would not have taken place. Just as a private businessman takes a loan to set up a factory, the Government too can take a loan to build highways.

Just as the private businessman repays the loan from factory's income, the Government could have repaid the loan from the revenues it gets from the highways.

But data show that such is not the case. According to the Economic Survey, the Government invested 7.1 per cent of the national income in the last decade. This has declined to 6 per cent in the last three years. The Government is taking loans for consumption rather than investment. The final assessment is as follows: The fiscal deficit is high but the reduction in investment has made it possible for the Government to take loans at low interest rates. Government consumption is being supported by these loans. Hence, there is little rise in prices. The problem remains that the growth rate has been low during the last five years. How do we explain the present high growth rate of 8 per cent despite the fiscal deficit remaining at high levels? One factor is good monsoons. Second is that the decline of the US economy and rise in outsourcing has made it profitable for global capital to flow out of the US into countries such as India. These FII inflows are buoying the economy.

The third and, perhaps, more important, reason is institutional reforms. There has been an all round reduction in government interference in the economy. Previously industries were restricted by a licensing regime. It has been dismantled now.

Previously, it was difficult to make even necessary imports. Now it is wholly open. Previously the premium for new issues was determined by the Government. Now companies are free to fix the premium. Previously, the judiciary was oriented in favour of labour rights. Now there is greater stress on their accountability. Strikes by government servants have, for example, been held illegal.

Previously rail travel was difficult because there was much uncertainty about return reservations. Now it is possible to take return reservations from any place. Such institutional reforms have removed the roadblocks in the economy and lent it some speed. These reforms are responsible for the recent spurt in growth rates. It appears that India is squandering away its good fortune by letting its fiscal deficit rule high. The Government's revenue expenditure has increased from 3.3 per cent in the last decade to 4-plus per cent presently.

The quality of government expenditure is becoming worse. But the benefits from monsoons, the decline of the US economy, and the institutional reforms have nullified the bad effects of this increasing revenue deficit. Interestingly, this situation is likely to remain stable. The business energy of the country has been unleashed. Hence, it will bear through high revenue and fiscal deficit.

But the Government will have to reduce its revenue deficit if India is to move towards the 10 per cent growth rate mark. At present, India is using the energies unleashed by institutional reforms to support revenue deficit and government consumption. The country should instead use them to support higher growth rates.

(The author, a freelance writer, can be contacted at: bharatj@nda.vsnl.net.in)