Fiscal dilemma

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Bikky Khosla | 02 Feb, 2016
What should have priority: fiscal consolidation or public spending? More and more as we are getting closer to the Budget day, this debate is gaining steam. There is a general agreement on the fact that the Budget must aim at spurring investment, but views differ on how to respond to this challenge. Loosening the fiscal purse-strings can help accelerate growth through public investment -- supporters of this view want the Centre to move away from its earlier set fiscal goals. But letting fiscal deficit slip may result in higher borrowing and thus put further stress on public finances -- another faction argues.

The RBI Governor last week cautioned against tinkering with the fiscal deficit target. Pointing to Brazil's experience, he viewed that such a move may hurt macroeconomic stability, which is currently the single most important strength of the economy during this period of global turmoil, and that both the Centre and the RBI should continue to bring down inflation. Earlier, NITI Aayog vice chairman Arvind Panagariya had also cautioned that deviating from the fiscal goal might impact the government's credibility. In contrast, chief economic advisor Arvind Subramanian had viewed that fiscal consolidation could be relaxed to boost public investment, in the background of weak corporate sector investment. The Indian industry has also urged the Centre not to cut spending to meet the fiscal deficit target for FY15.

While both sides of the argument have valid points, it seems maintaining a proper balance holds the key. A recent RBI study shows 27 percent decline in capital expenditure by corporate India in 2014-15 over the previous year. I think nothing but lack of demand is the most responsible for this investment slump. Weak corporate results are not helping; balance sheets of banks, which finance most of the investment in India, are stretched; exports have been declining; and rural demand is weak. In this situation, the government must come forward to play an active role in pushing investment and thus demand and economic growth. In addition, investment in infrastructure will also help yield long-run returns.

Fiscal prudence is also important. A minor fiscal slippage may not hurt investor sentiment much but a big one could certainly do that. So, care must be taken in this respect while also ensuring that there is no sharp cut in public expenditure. This will not be easy, particularly considering the limited fiscal space currently available with the government, but priority should be given to cutting down wasteful expenditure, rationalizing subsidies and controlling leakage and making the best of oil prices which are likely to remain soft in next fiscal. In addition, I think there is still enough scope to improve the ease of doing business in order to attract both domestic and foreign investment into the country.

I invite your opinions.