By Ishita Misra
The government expenditure had been steadily increasing in the first half of the year in order to cushion the economy against the shocks of demonetisation in November 2016 and subsequently, the implementation of a new tax regime in July 2017. However, with the economy on its way towards a recovery, the government has now shifted its attention towards controlling the rapidly increasing fiscal deficit. As a result, the government cut down on expenditure for the second consecutive month in September, including a cut in the much-needed capital expenditure (capex).
Squeezing the capex
On a year-on-year basis, the government cut down on its capex by 28% in August, to Rs 14,522 crore and by 16% in September, to Rs 37,741 crore. Despite the high government expenditure in the previous months, the squeeze on capex was so intense that the total percentage of the budget expenditure already spent in the first half of 2017-18 declined in comparison to the percentage spent last year.
In an attempt to curb the fiscal deficit, even the revenue expenditure was compressed by 11%, to Rs 1,61,999 crore in the first half of the financial year. The compression of spending has allowed the centre to accumulate a fiscal surplus of Rs 26,107 crore in September. Consequently, the fiscal deficit came down to Rs 4.98 lakh crore from Rs 5.25 lakh crore in August.
Why can’t we keep borrowing indefinitely?
Even though it would be convenient for a country to have high fiscal deficits without having to worry about any repercussions, that is not the case. Running high fiscal deficits not only leads to accumulation of high-interest payments in the future, but the general consensus among economists and other policymakers is that large and persistent fiscal deficits are detrimental to macroeconomic stability. This is because large and persistent deficits tend to increase inflationary potential, crowd out private investment, weaken the balance of payments, and last but not least, make financial sector reforms more difficult.
An example that demonstrates the impact of persistently high fiscal deficits is that of the early 1980s in India. In the 1980s, the total fiscal deficit rose from 6% of the GDP in early 1980s to 8% of it around 1985 and stayed in the range of 8-9% till 1990-91. The steep increase in the deficit is believed to have been one of the prime causes of the 1991 balance of payments crisis. According to Vijay Joshi and Ian Little, “…the crisis of 1990-91 and 1991-92 is wholly attributable to the lax fiscal policy of the preceding years”.
Learning from the crisis, the central government made efforts at fiscal consolidation. The efforts brought down the fiscal deficit from above 9% of GDP in 1990-91 to 6% in 1996-97. The connection between fiscal deficit and a healthy economy was made stronger by the fact that this reduction was followed by a revival of the economic growth rate from just over 1% in the crisis year to 8% in 1996-97.
Disappearance of the saving grace
During the period of declining economic growth rate in India, namely, post-demonetisation and during the implementation of GST, government expenditure was the saving grace that propelled economic growth at its comparatively slow pace. The growth in government spending held up close to 9.5% and continued to support overall economic growth. The magnitude of the increase in government expenditure can be observed through the latest data from the Controller General of Accounts. It shows that the government exhausted 92.4% of its fiscal deficit target within just the first four months of the fiscal year 2017-18.
Considering the crucial role that the government expenditure has played in boosting economic growth, a sudden decrease in the government expenditure could have a negative impact on the economic growth rate despite the pick-up in economic activity in the last two months. Furthermore, in order to reach this year’s fiscal deficit target of 3.2%, a further contraction of public spending can be expected. Therefore, in order to ensure that economic growth is not adversely affected, the government needs to ensure that the crucial sectors continue to receive the required inputs through increased private investment.
Featured Image Source: Pixabay
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