India has become the fastest-growing emerging market country, likely growing close to (or above) its potential growth (generally assessed recently at about 7%). The authorities are rightly keen to restore higher potential growth over the medium term through overdue structural reforms that would better integrate the domestic economy, raise the business climate, and more fully utilise India’s young population.
Against this background, what should the coming 2016-17 budget propose for the fiscal stance? Is there a growth-oriented case to raise public investment and the deficit target above the planned fiscal consolidation, which currently targets the Central Government deficit at 3.5% of the GDP in 2016-17, falling to 3% (as also recommended by the Fourteenth Finance Commission) in 2017-18?
This issue also needs to consider the present global environment, where risks have significantly shifted to vulnerabilities in emerging markets. This is partly because underlying growth potential has declined in many emerging markets, and capital flows are responding to the U.S. Federal Reserve (Fed) “lift-off”.
In particular, markets are concerned about corporate and bank balance sheets in many emerging markets that are currently regarded as being overstretched. Higher leverage of the private sector and greater exposure to global financial conditions have left emerging markets more vulnerable to capital outflows and deteriorating credit quality. This vulnerability will deepen if policies in many emerging market countries rely more on debt-led investments.
Given this context, markets are closely following how policies are being adjusted in key emerging markets, and whether countries are putting financial policies beyond fundamentals. The challenge is to restore productivity and growth fundamentals in many emerging markets. In countries where household savings have been preempted by the public sector, this warrants reversing the crowding out of corporate investment, as has been the case in many emerging markets with high public sector deficits, and this vulnerability has become more significant with the Fed lift-off.
Let us look at the regional context, especially in connection with China, whose situation is affecting markets and putting pressure on its currency for several reasons. Markets have reacted adversely to China’s policy reactions to market volatility. In addition, China’s continuing attempts to keep growth above its potential, through fiscal and monetary stimulus, are compounding China’s overall debt situation, reducing market confidence in its policy framework, and adding to downward pressures on the yuan.
How does the global and regional context affect India, in particular, the room to change its fiscal stance and target greater public investment through a higher fiscal deficit in 2016-17?
There are several perspectives that counsel against this approach:
First, there is the potential impact on financial markets, which is particularly important given rising concerns over the vulnerabilities of emerging markets. For India, retaining market confidence in the policy framework and ensuring market stability in the rupee is especially important at this stage. Most importantly, markets should not see India trying to keep growth above potential through fiscal easing and monetary stimulus, as has been the rising concern about China. Equally, markets might be concerned that fiscal easing is indicative of government concern about India’s growth momentum.
Second, would exacerbate the legacy of crowding out the private sector, which has been a problem for productivity and growth in India. In particular, it could work against the need to raise corporate investment in India and raise the high extent of financial saving that is already pre-empted by the public sector.
Third, India’s current fiscal consolidation plan, as announced by the union finance minister last year, rightly aims at rebuilding the country’s fiscal policy space. India needs greater fiscal space for a number of reasons, and especially to build room for exercising counter-cyclical aggregate demand management policies.
Fourth, in the context of building fiscal space, it is equally important to improve the quality of consolidation and make it more growth enhancing. As the government has well recognised, this requires significant tax reforms and further rationalization of subsidies that would also help create space for higher capital spending and social expenditure.
In summary, given that India’s growth rate is presently above 7%, which is high in the context of the global economy, it would be counterproductive (for both cyclical and structural reasons) to undertake further fiscal loosening that could alter India’s debt dynamics.
Anoop Singh is Distinguished Fellow, Geoeconomics Studies at Gateway House: Indian Council on Global Relations.
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