Is fiscal deficit of 3.2% of GDP written in stone?

Deficit isn’t necessarily a bad thing. Much depends on how public money is allocated and spent and what the macroeconomic situation is

For the current fiscal year, the government of India has budgeted a total expenditure of ~21,46,735 crore, tax revenue of ~12,27,014 crore, non-tax revenue of ~2,88,757 crore, recoveries of loans of ~11,932 crore and other capital receipts of ~72,500 crore. Given these numbers, the government’s fiscal deficit budgeted for 2017-18 works out to ~5,46,532 crore. With the gross domestic product (GDP) for 2017-18 projected at ~168,47,455 crore, the current year’s fiscal deficit has been budgeted at 3.2 per cent of GDP.

Considering the current state of the Indian economy, should the government stick to this number of 3.2 per cent of GDP, or would it be advisable for it to relax the limit set by this number? Some experts say the government should stick to this number, on the grounds that a fiscal deficit higher than 3.2 per cent of GDP will be inflationary and damage the government’s credibility. Some say that given the slowdown in the economy and the need for a fiscal stimulus, the government should go ahead and spend the requisite additional money to stimulate the economy.

In my view, the fiscal deficit, as it is currently defined, doesn’t make much sense. It only captures the government’s borrowing requirements. What about the borrowings done by central public enterprises to finance their investments? What about the state governments’ borrowings to finance their fiscal deficits? What about the huge borrowings done by some public entities (for example, state power distribution companies) to finance their losses? If one is really concerned about the macroeconomic effects of fiscal deficit, one must consider all these borrowings.

Suppose one does all this and comes up with a public sector deficit (deficit of all public entities, including the government of India) of, say, 10 per cent of GDP. Will those experts, who believe that the government must stick to the budgeted fiscal deficit of 3.2 per cent of GDP, say that public sector deficit of 10 per cent of GDP is okay, but public sector deficit of 11 per cent of GDP is not?

Deficit is not necessarily a bad thing. Much depends on how the public money is allocated, how efficiently and effectively it is used, what public entities other than the government are doing or planning to do, and what India’s macroeconomic situation is.

I believe that given India’s current macroeconomic situation, the country can easily afford a one percentage point increase in its public sector deficit.

But how will the present government at the Centre ensure sensible management of its expenditures? It keeps on announcing public interventions, but are they being monitored and evaluated the way they should be?

Monitoring? Monitoring of what? It should be monitoring of inputs, activities, outputs and outcomes, as also monitoring of how strong the causal links between inputs, activities, outputs and outcomes are.

Regarding the issue of evaluation, I believe it will be a great idea to develop a culture in which policymakers demand rigorous impact evaluations of government programmes and schemes, not because they have to comply with any requirement, but because they really want to know the answers to the impact evaluation questions of what works, under what conditions it works, for whom it works, what part of a given programme or scheme works, and at what cost. All this, so that they may draw appropriate lessons from these answers and use them while designing and implementing government programmes and schemes in the future.

But does the government have the requisite capacity to carry out meaningful monitoring and evaluation of public interventions? My assessment is it does not. It urgently needs to develop this capacity.

The bottom line is that the fiscal deficit of 3.2 per cent of GDP the government has budgeted for 2017-18 is not written in stone. Given the current state of the Indian economy, there is a strong case for relaxing this limit of 3.2 per cent of GDP. But before the government decides to do so, it must put in place a credible mechanism to ensure that the money it spends is used only for providing public goods, and is used efficiently and effectively.

What needs to be stressed is that the relationship between public spending and the macroeconomic situation is not linear. Much depends on how the public money is allocated and how efficiently and effectively it is used. The efforts that the government makes to improve the management of its expenditures will pay huge dividends — the country’s macroeconomic situation will be much better.

May I also urge the Department of Economic Affairs in the Ministry of Finance or the NITI Aayog or the Reserve Bank of India to start compiling data on the deficits of all public entities in India and come up with a credible estimate of India’s public sector deficit. We don’t have these data. We must have them. This will allow us to monitor India’s public sector deficit.

Will the government be able to put in place the above mechanism well in time before it starts spending the additional money? Given the present government’s record so far, I am not very hopeful. But I will be happy if I am proved wrong.