Striking the right fiscal balance

If the events after September 2008 told us anything about such multilateral agencies as the International Monetary Fund and the World Bank, it was just how far behind the curve of complex economic realities they had fallen. The IMF's policing of exchange rate stability has become increasingly futile in a world where currency wars simmer and erupt occasionally as more than one emerging economy attempts to keep its currency from appreciating in the face of flooding capital flows. Now the World Bank cautions India and other South Asian countries against “fiscal slippages” and stresses the need to pursue tighter monetary policies.

In its latest “Global Economic Prospects” report, the World Bank asks India to cast an eye on the challenges that high-income European countries “with large deficits and debt-to-GDP ratios” are confronting, as an object lesson for staying the course of fiscal prudence. But the example is not strictly apposite nor is it illuminating; the European fiscal crisis has been brought about by the undue profligacy of the weaker southern rim European Union member-governments and housing bubbles (in Spain, for instance) when times were good and their inability to service rising debts when the bubbles burst and capital fled from the collapsing economies. The solution that stronger members, such as Germany and France, have imposed — fiscal discipline and austerity, that are music to World Bank ears — call for slashing budgets just when governments need to find and spend more to generate employment and investments. Fiscal austerity may heighten economic hardships without the promise of new investments generating employment in the near future. On both counts India is different: for all their shoddy governance, New Delhi and the States have kept some rein on spending and, while the current account deficit and external debt may be troublesome, the Reserve Bank of India has been moving in step with developments, attempting to balance growth with calibrated monetary tightening, even at the best of times. The next fiscal may witness increased spending and so some “fiscal slippage”, but given the lackadaisical investment picture right now, that may be warranted in the larger interests of sustained economic expansion. The World Bank should remember that enhanced government spending and fiscal cuts after September 2008 did pay dividends in higher revenue collections; right now private capital again runs shy. A report in this paper points to delays in capital spends of companies on account of land acquisition problems; the 2G scam has got banks wary of core sector lending.

Fiscal balance is not cast in stone; given the perceptible downturn in economic activity, a flexible approach to public spending may become necessary, once again.

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