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November 01, 2017

Setting the Fiscal Deficit in India[1]

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Posted by Anand P. Gupta[2]

For the current fiscal year, 2017-18, the Government of India has budgeted a fiscal deficit of Rs. 5,46,532 crore, equivalent to 3.2 per cent of GDP.  Is this number written in stone?  Some experts say that the Government should maintain the current deficit, because a fiscal deficit higher than 3.2 per cent of GDP will be inflationary and will damage the Government’s credibility.  Others say that, given the slowdown in the economy, the Government should increase spending and borrowing to stimulate the economy.

In my view, deficit financing is not necessarily a bad thing.  Much depends on how public money is allocated, how efficiently and effectively it is used, what public entities other than the Government of India are planning to spend and borrow, and India’s macro-economic situation. Given the current state of the economy, there is a strong case for relaxing this limit of 3.2 per cent of GDP, perhaps by an additional 1 percent of GDP. At the same time, the Government needs to put in place a credible mechanism to ensure that the money it spends is used only for providing public goods, and is spent efficiently and effectively.

An exclusive focus on borrowing at the central government level, however, is too limited. In my view, the fiscal deficit, as it is currently defined, doesn’t make much sense. It only captures the Government of India’s borrowing requirement.  What about the borrowing done by central public enterprises to finance their investments?  What about the State Governments’ borrowings to finance their deficits?  What about the huge borrowings done by some public entities at federal and state level (for example, state power distribution companies) to finance their losses?  If one is really concerned about the macroeconomic effects of the fiscal deficit, one must consider all these sources of finance. Unfortunately, comprehensive and reliable data on borrowing by the wider public sector is currently lacking. 

Another key issue is how the Government should manage its expenditures. The Government keeps on announcing public interventions, but are they being monitored and evaluated in an appropriate way?  The Government has not yet developed a methodology for monitoring the inputs, activities, outputs and outcomes related to its spending programs and projects, or for analyzing the causal links between these various measures of spending performance.

What is needed is to develop a culture in which policymakers demand rigorous impact evaluations of the government’s spending policies and programs.  Such studies would help policymakers analyze what works and under what conditions, draw appropriate lessons, and use these lessons to inform the future design and implementation of the Government’s spending policies and programs.  Unfortunately, I don’t believe that the Government currently has the requisite knowledge and skills for undertaking studies of this kind. It urgently needs to develop this capacity.

It is important to note that the relationship between public spending and the macro-economic situation is not linear.  Much depends on how public money is allocated and how efficiently and effectively it is used.  Given this, the efforts that the Government of India makes to improve the management of its expenditures will pay huge dividends, and the country’s macro-economic situation will become much better.

Finally, may I 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.  These important data currently do not exist, but they are essential if we are to monitor overall fiscal trends and performance in India.

[1] An earlier version of this blog article appeared with the title “Is the fiscal deficit of 3.2% of GDP written in stone?”, in Business Standard, October 12, 2017.

[2] The writer is a former Professor of Economics at the Indian Institute of Management, Ahmedabad, India.  Email: anand@EconomicManagement.com

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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