By Ishita Misra
The combined fiscal deficit of the Centre and State governments presently stands close to 6 percent of the GDP making the economy extremely vulnerable to instability.
Therefore, in the bi-monthly monetary policy statement, Reserve Bank of India (RBI) Governor, Urjit Patel, commented that the government needs to tread cautiously when it comes to fiscal actions to ensure macroeconomic stability in the country. He clearly made a reference towards the impending farm loan waivers and fiscal stimulus led economic growth.
Farm loan waivers and fiscal stimulus
The April- June quarter recorded a three- year low economic growth of 5.7 percent. Under the pressure of reviving growth, the Centre is planning to boost the economy using fiscal measures. These measures include a stimulus package of Rs 40,000 crore and farm debt waivers.
So far, the states of Uttar Pradesh, Maharashtra, Punjab, Karnataka and Rajasthan have announced farm loan waivers in the year 2017-18. However, only two of these states, Uttar Pradesh and Punjab, have made provisions in their budgets for the increase in expenditure for 2017-18 to accommodate these waivers.
Therefore, farm loan waivers in the other three states coupled with the stimulus package will directly impact the fiscal deficits of these states and lead to an increase in the overall fiscal deficit.
Real value added growth figures revised
In the monetary report, the RBI also revised its projection of real gross value added (GVA) growth for 2017-18 from 7.3 percent in August 2017 to 6.7 percent. The central bank said that the loss of growth momentum resulting in the three- year low of 5.7 percent in the first quarter, along with the low first advance estimate of kharif food grain production are some of the major setbacks that are impacting GVA growth projections.
Implementation of the GST appears to have had a negative impact in the short term, leading to uncertain prospects for the manufacturing sector. This may further delay the revival of investment activity, which is already subdued by stressed balance sheets of banks and corporates and further hamper growth. The slowdown in growth is likely to decrease the tax revenue, potentially widening the Centre’s fiscal deficit even more.
Fiscal deficit and inflation
In response to the government’s plans for fiscal policy actions, the RBI has warned against the combined effect of a stimulus package and farm debt waivers, claiming that it could increase the fiscal deficit by 1 percentage point, the effects of which will be seen in the form of increased inflation.
Quoting a 2005 study, the RBI said that there exists a relationship between fiscal deficits and inflation according to which, higher fiscal deficits can lead to an increase in inflation expectations and the actual inflation. Thus, the 1 percentage increase in fiscal deficit could lead to a 0.5 percent rise in inflation.
In addition, the decline in economic growth and the consequent fall in tax revenue will further lead to an increase in fiscal deficit and inflation.
What lies ahead?
Even though the revised projection of growth for the year 2017-18 is lower than the earlier projections, it does not signal a lower level of growth in the second half of the year. The revised projection as a whole is consistent with an acceleration of 7.1 percent growth in the third quarter and 7.7 percent in fourth quarter.
During the period of a growth slowdown, increased government spending is an essential factor that allows the economy to keep growing. However, it can severely impact the macroeconomic stability by increasing the fiscal deficit.
Fortunately, the RBI’s surveys point to an increase in consumer confidence and buoyant business expectations for the third quarter of 2017-18, that can boost the economy and ensure rapid economic growth in the third and fourth quarter.
Featured Image Source: Sole Treadmill via VisualHunt / CC BY
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