Fiscal stability is the first casualty of economic turmoil anywhere. If Covid revealed anything new, it was how vulnerable everyone was to the idea of a balanced budget. Like many other economies, India reduced fiscal spending in response to the pandemic crisis. The centre’s gap between inflows and outflows accounted for 3.5% of total output, but ended at 9.3% in 2020-21, when its revenue shrank on the back of a shrinking economy; And this week’s data pegged last year’s fiscal deficit at 6.7%, slightly lower than the 6.9% projected earlier, thanks mostly to recovery, which meant more tax money than the increased pie of nominal national income. Here ‘thank you’ is relevant because an overly lax fiscal policy not only creates macro-level risks like inflation, it is also prohibited by the 2003 law (whose escape hatch came in handy). As to the rein of that overrun, Finance Minister Nirmala Sitharaman sometime before the two Covid waves laid out a great path forward for our fiscal gap. The Centre’s aim, it said in early 2021, was to reduce this to 4.5% by 2025-26. With the jump in price now playing spoiler, however, we should bring it down very soon. faster. In fact, there may be a need to step down the fiscal path — and a Nadalesque one at that.
Certainly, the inspiration for the revised financial path can be drawn from tennis, in particular Rafael Nadal’s legendary top-spin shot, which stunned the audience with his win over top-ranked Novak Djokovic at this year’s French Open . Performed with the aid of an arc drawn by the racket, this stroke sends the ball spinning against the air so that it swings rapidly down the net. The effectiveness of the top-spin at top speed on the clay court was on full display in Nadal’s fury. It is not easy to overcome, but India’s financial sector will need to take a similar trajectory, given the Reserve Bank of India’s capture of price volatility. Monetary policy was tightened last month, but RBI’s prime lending rate remains negative in real terms. While further increases are clearly needed, tight money in itself is unlikely to be enough. Recall that India’s big jump on projects aimed at boosting income began after the economy emerged from its Covid crackdown. The plan is to keep this pump actively so that more money can be taken out. Since infrastructure is at the core of this financial thrust and everything takes time to build, the extra money in the game would have fed inflation with some lag.
If prices must calm down, mega spending can’t last long without the revenue to pay for it. In the budget presented in February, this year’s deficit target was set at 6.4%. Since then the impact of external shocks has led to increased outlay on welfare, subsidies etc apart from some relief on fuel taxes. Since the latest tax cut was part of a well-publicized effort to drive down retail prices, it signaled an intention not to wash away our huge pile of public debt. This is a good sign. With the tax boom in flow (as seen in the GST collection), even the gloomy situation remains and threatens to worsen (witness the EU’s Russian oil embargo), from the plan. A small fiscal would not be possible. Also, to the extent that our economy still needs support, it would be appropriate for the Center to go by its current plan. Its stance has been that the state will withdraw once private investors initiate enough investment to sustain the economy’s expansion. Sadly, its signs are flickering again. All that said, we face tough times ahead. If inflation doesn’t decline by the end of the year, our fiscal glide path will need to take a sharp dive.