On Saturday, the finance ministers of the Group of 20 countries including India will descend on London to discuss if it is indeed time to discuss an ?exit strategy??a plan to unwind the unprecedented fiscal stimuli countries provided to their economies to shore up growth in the aftermath of the global financial crisis.
The developed world is itself quite divided on the timing. Though the global economy is beginning to recover slowly, the United States and the United Kingdom do not want to jeopardise growth prospects by withdrawing early. Germany and France are pushing for an early exit. In fact, they did not want a stimulus the day after they reluctantly agreed to one. The dominant or key question at the London meeting will be when to exit.
India is beset with its own problems, drought adding a new dimension. It has, however, made it clear that the expansionary fiscal stance it adopted since September 2008 needs to be reversed. More than once finance minister Pranab Mukherjee has expressed his intention to get back to the path of fiscal prudence at the earliest. He actually drove home the point in a meeting of the full Planning Commission chaired by the Prime Minister himself on Tuesday.
There are no two views that India has a runaway deficit?6.8 per cent of gross domestic product, highest in 16 years. Next year, what will hurt growth prospects more is a supply constraint rather than a shortage of demand. When supply is short, inflation is a real threat, and continuing with additional spending will only fuel prices. Fiscal consolidation during such times turns out to be pro-growth, exerting a downward pressure on interest rates, economists will tell you.
While all this is absolutely true, Mukherjee will realise how daunting the task is?with drought demanding copious Central funds, lower growth prospects this year and the next, inflation expected to rear its head again by March 2009, and a resource shortfall to the tune of Rs 1,60,000 crore?in the coming months. Even as he commences unwinding on the fiscal side, the Reserve Bank of India?already jittery over the inflation outlook?will rush to reverse its monetary stance.
India realised the severity of the global financial crisis last year only after it spread to the real economy. There was much denial in the early period of the crisis. It was almost July 2008 when the UPA government first acknowledged that India will be hit indirectly because of the crisis. A staccato of stimulus packages followed between September last and July 2009. These had two broad components?tax cuts and expenditure increases, and monetary expansion.
Political parties in India and the ruling United Progressive Alliance government were in the midst of preparing for general elections when confronted with the harsh realities of the global crisis.
The fiscal stimulus, naturally, got aligned to the political agenda of the UPA that was seeking a bigger mandate from the people for a second term. So, much of the extra resources or stimulus moneys was directed towards the UPA?s flagship programmes such as National Rural Employment Guarantee Scheme, Bharat Nirman, Jawaharlal Nehru Urban Renewal Mission, etc. Political expediency may have demanded this of the UPA then, but the difficulty now will be in unwinding these.
When Mukherjee said he would restore the fiscal deficit to 5.5 per cent of the gross domestic product (GDP) by 2010-11 and further to 4 per cent by 2011-12, he had not anticipated the drought and its adverse fallout on agricultural output. He only knew that the 6.8 per cent of GDP deficit projected for 2009-10 was not sustainable. Sanity had to prevail on the fiscal side. For this, he will have to hike taxes (restore the rates to pre-September 2008 levels) and curb expenditure.
Raising taxes, we all reckon, is probably easier. Cutting spending will be difficult. What invariably happens in such a scenario is fund allocations for all schemes, including the good ones, get trimmed. Worse, new schemes are discouraged. They are put on the backburner to accommodate existing ones and the flagships. Even so, unless the finance minister directs his scissors to flagships, he can achieve little ?unwinding? or ?exit? on the expenditure front.
If the intentions of the government and the Reserve Bank of India are indeed to bind themselves to fiscal rectitude in the ensuing years, the market borrowings to meet the stimulus requirements should be of shorter duration.
The lowest tenure paper that the RBI has ever issued is five years. It makes immense sense to opt for three-year papers such that Mukherjee finds himself squeezed for funds in 2012. The huge repayments will ensure he does not have the money to top-up various Plan schemes. Besides, it will also save on interest payments. Good intentions, without policy action, are simply not enough.
The author is national business editor, The Indian Express