Growth or fisc?

M Y Khan | Updated on January 20, 2018 Published on February 24, 2016


One comes at the expense of the other

The biggest challenge for the finance minister in the upcoming Budget is how to mobilise additional resources without raising taxes across the board or cutting down revenue expenditure, so that public investment can be enlarged in size and quality.

The Union Budget 2015-16 had projected a deficit of 3.9 per cent of GDP for 2015-16 and about 3.5 per cent for 2016-17. Though the Centre has more or less achieved the target for 2015-16, the process of consolidation has slowed down. The Centre has been trying to narrow the fiscal deficit by acquiring the profits of public sector undertakings, public sector banks and the RBI, but not by economising on non-productive expenditures.

Investment slows

The consolidation of fiscal deficit has resulted in the slowing down of investment in the economy. As such, domestic gross capital formation fell from 36.6 per cent in 2012-13 to about 30 per cent during 2014-15. The decline in investment has been reflected in the GDP growth rate, projected to be around 7.6 per cent in 2016-17. This growth trend is hardly adequate to sustain India’s huge consumption and required domestic savings and investment in economy.

At present, the domestic savings rate is relatively low at about 29 per cent of GDP. It means the government has to push up investment by encouraging foreign funds to fill the gap and if possible the RBI has to raise the interest rate to attract foreign resources.

Any further reduction in the RBI’s policy rates has been halted in the bi-monthly policy statement of the RBI in February. The RBI lending to banks and then banks to corporate sector will not help raise growth but only lead to a rise of non-performing assets, which means there is no room for further cuts in the repo rate.

Growth imperative

The investment by the private sector is determined by the net profits or net rate of returns on assets. Now, domestic demand is somewhat gloomy for goods and services from consumers. Investor sentiment is also down, so there is little hope of enhancing private sector investment without incentives to investors by way of cuts taxes and excise duties, which will reduce the Centre’s revenue receipts, hampering fiscal consolidation.

Hence, it is not the necessity to further narrow the fiscal deficit, as the government is duty bound to enhance resources for investment in the economy to achieve 9-10-per cent growth by 2018-19. The public has not forgotten the cost of inflation due to supply side shortage. So, there is a need to launch new investment programmes to generate high growth and diversified development. Given the growth imperative, focusing on fiscal consolidation at this point is not as necessary as improving growth.

Deficit financing, linked to productive investment, while ensuring against corruption and mis-allocation of resources can have a positive impact on growth. On the revenue side, the government, besides raising taxes on entertainment and luxury goods, can also consider expenditure-switching techniques. For instance, resources from revenue expenditure can be shifted to capital expenditure.

The ministers should realise that a 7 per cent growth rate cannot compare well with that of developed countries. A one per cent growth of GDP of a country like the US will be higher in terms of absolute level of GDP than India’s 7 per cent GDP growth.

The writer was director of the research department at the RBI

Published on February 24, 2016
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