– By Chinmay Joshi
The recently released India Development Update: India’s Trade opportunities in the Changing Global Context by World Bank predicted a positive outlook for India. It has estimated that the real GDP growth for India to be at 7.0% in 2024-25 and 6.7% in 2025-26 and 2026-27. However, ominous signs emerge in the ensuing period due to several domestic as well as external factors. This has also been reflected in the latest monetary policy statement released by the MPC-RBI where the real GDP growth is predicted to reduce to 7.2% in 2024-25 from 8.2% recorded in 2023-24. Also, the growth prospects for the economy subdued in Q1 of 2024-25 where the real GDP growth registered a growth rate of 6.7% as compared to 8.2% in Q1 of 2023-24 as per the recently released national income data by the National Statistical Office (NSO), MOSPI, GoI for the Q1 of 2024-25 on August 30, 2024, recording a significantly lower print than the latest MPC-RBI estimates of 7.1% in Q1 of 2024-25.
Bleak estimates of growth in the future, upcoming elections in various states and political compulsions for formulating pro-poor policies are among various reasons that prompted central and state governments to adopt several expansionary fiscal policies in recent days. It is an undeniable fact that the adoption of appropriate supportive fiscal policies is essential where immediate relief is to be given to the poor, downtrodden and deprived sections of society in order to enable them to overcome the pressing situations. Such financial support has certainly proved to be a great respite to the weaker sections of society especially during the natural calamities and health disasters such as the Covid-19 pandemic. However, it is also important to note that the continuity of such fiscal support for free of cost, popularly known as ‘freebies’, during normal times will have significant negative implications for the exchequer, as these can cause severe strain on the government’s budget.
Fiscal support extended in recent months in terms of provision of free food grains for 5 years starting from January 2024 under the ‘Pradhan Mantri Garib Kalyan Anna Yojana’ (PMGKAY) to more than 80 crore people by the central government; ‘Mukhyamantri Majhi Ladaki Bahin Yojana’ in Maharashtra; ‘Mukhyamantri Ladli Behna Yojana’ in Madhya Pradesh; free electricity, free water, farm loan waiver schemes in various states, inter alia, has a potential to have a dilapidating impact on governments’ coffers. For instance, the scheme under the PMGKAY is expected to cost around Rs. 11.80 Lakh crores in 5 years to the central government while the scheme in Maharashtra is expected to cost the state government to the tune of Rs. 46, 000 crores annually.
Doling out of freebies has a capacity to impact the fiscal deficit negatively, particularly in the absence of adequate revenue generation. This necessitates the government to finance such schemes by resorting to additional borrowings. A continuous increase in borrowings will have a detrimental impact on government finances, manifested in terms of growing burden of principal as well as interest payments worsening the primary balance. The ill effects emanating from these deficit indicators can force the government into the vicious cycle of deficit and debt. This will further have adverse repercussions for the debt sustainability in the wake of rising public debt.
In spite of providing a leeway to the policymakers in stimulating the economy, there is a risk of rising inflationary pressures as adoption of expansionary fiscal policy measures in terms of freebies provide monetary or non-monetary resources in the hands of people. An increase in disposable income will lead to an increase in aggregate demand in the economy. Moreover, the existence of a mismatch created by the rise in aggregate demand vis-à-vis a less than proportionate rise in aggregate supply has the potential to elevate the price levels in the economy. In this context, it is to be noted that India has been experiencing persistence of elevated inflation, albeit some sign of a positive trend emerging in the past couple of months. Furthermore, elevated level of inflation erodes the consumption expenditure which has been reflected in the private final consumption expenditure (PFCE) which declined from 6.77% in 2022-23 to 4.02% in 2023-24 and reduction in the share of PFCE in GDP from 58.0% to 55.8% during the same period as per the NSO, MOSPI, GoI estimates.
Freebies result in a decrease in the productive capacity of people since they heighten their sense of reliance on the government. In this regard, it is important to note some of the findings of the RBI report on State Finances: A Risk Analysis released in June 2022 which points out that freebies are detrimental to credit culture, have a distortionary impact on prices, discourage private investment, and reduce labour force participation. Together this will eventually have negative ramifications for economic growth. The extension of fiscal support through freebies on a continuous basis to a large section of the population also suggests that a meagre success has been achieved in ensuring equitable, sustainable and all-inclusive economic growth.
It is imperative that policymakers must objectively evaluate the costs and benefits of such expansionary policies so that resources are employed for more productive purposes. Every effort should be made to reap maximum benefits by ensuring optimum utilization of such policies, besides minimising opportunity costs arising out of such freebies. Policies should also be directed towards the creation of capital assets which are crucial in generating employment opportunities; emphasising education and healthcare facilities; increasing focus on research and development, innovation, and adoption of newer technologies, which will benefit in the long run rather than focusing on short run gains.
A well targeted and cost-efficient freebies during the crisis period will certainly prove to be a boon for the economy, nevertheless extending and prolonging of such policies for myopic political gains will eclipse the economics and has potential to leave the economy in the lurch. Therefore, timely withdrawal of such fiscal stimulus assumes significant importance. It is pertinent to keep in mind that freebies should only be employed for ‘ad hoc’ reasons and not become an instrument or policy tool aiding to paint a sanguine picture of the economy. In this context, it is worthwhile to remember the words of Nobel Laureate Milton Friedman: “There is no such thing as a free lunch.”
(Chinmay Joshi is a Research Associate, Finance and Economics, at Bhavan’s SPJIMR, Mumbai.)
(Disclaimer: Views expressed are personal and do not reflect the official position or policy of Financial Express Online. Reproducing this content without permission is prohibited.)