Economic growth took centre stage in India last week. The government unfolded its annual budget plan for 2013-14, while the national statistics office issued gross domestic product (GDP) data for the three months ended December. Putting the two together, what does fiscal policy do for growth, which sank to 4.5% last quarter?
If correcting macroeconomic imbalances is good for growth, then fiscal discipline has at last begun to move in that direction. The estimated fiscal deficit for 2012-13 was a tad lower than targeted at 5.2% of GDP, and is forecast to shrink to 4.8% of GDP in 2013-14. Government dissaving will reduce by 60 basis points to 3.3% of GDP. One basis point is 0.01%. Current fiscal effort, measured by the primary deficit—directly under control of the government as it excludes interest payments—is half a percentage point, lowering to 1.5% of GDP next year. Nominal GDP growth is projected at 13.4% for 2013-14. Assuming mean projection of 6.4% real GDP growth, inflation will then average 7% next year. Against this setting, total expenditure growth is budgeted at 9.8% in real terms—a 3.7 percentage point increase over the previous year (this grew 6.1%) and outpacing real GDP growth almost as much.
How does this impact aggregate demand? Given the existence of a negative output gap, the fiscal impulse imparted to the economy is unlikely to be expansionary. On the other hand, it may not subtract much from growth either. That’s because the pace of fiscal consolidation actually slows relative to the second half of 2012-13, where much of the fiscal correction was compressed, led by a sharp, 20.4% contraction in capital spending. In 2013-14, that loss is made up with a 42.2% rebound in capital expenditure growth. A stimulus to business spending comes from liquidity improvement measures for infrastructure and a 15% investment allowance for new, high value investments. This might be insufficient to restore the capex cycle, but the issues surrounding investments are far more serious and extend beyond the budget for resolution. The fiscal stance thus walks the thin line between the need to consolidate and support an economic recovery.
Do these trends imply reduced macroeconomic risk? Not entirely. The current account problem isn’t meaningfully addressed, even as a shrinking fiscal deficit will reduce the savings-investment gap somewhat. However, a structural shift to address the current account gap, or a move towards sustainable, export-generated earnings via productivity improvements, is absent. Instead, there’s yet more effort to expand the supply of short-term, foreign financing and an announcement for the issue of inflation-indexed bonds, whose effectiveness in shifting savers away from gold is yet unknown. A positive step here is to elicit private participation in coal, another rising import.
Fiscal slippage risk exists too. The correction is largely driven by over-optimistic revenue assumptions—19% growth in tax revenues and hefty income from one-off operations—asset sales (133%), dividends (33%) and auctions (45%)—plus under provided subsidies. Realizing these targets hinges critically upon the output cycle, oil prices and the rupee as well as regular diesel price adjustments in the coming months.
Nonetheless, the meaningful fiscal influence upon the economy will come from abating the threat of a ratings downgrade, lesser demand boost and, hence, more room for monetary policy, all of which should support growth.
Renu Kohli is a New Delhi-based macroeconomist. She is currently lead economist, DEA-ICRIER G20 Research Programme and a former staff member of the International Monetary Fund and Reserve Bank of India.