'De fiscal deficits

hurt

economic growth?'

i.t

It boils doun to whether greater goaernment spending malces upfor lawer priaate
wnwnrytian or whether, through higher interest rates or inflatinn, it lrurts it
DEBATE
fight
the current economic downturn, has bloated expenditures and taken government deficits to new highs across the globe. In India too,
the discretionary stimulus as well as some populist moves, pushed
al deficitlo-a-budpeted 6.8 oer cent of GDP in 2009-10. This rehe unprecedented diseretionary fiscal stimulus, put into action to

age-o
demerits of deficits, which
remains one of the most contested economic issues, to the fore.
There is nothing wrong with the govemment running a deficit per se. The government has to incur deficits to finance its revenue and expenditure mismatches and also to finance investments. The problem arises when the deficit level
becomestoohighandchronic. Theill-effects of highdeficits arelinkedtotheway
they,are financed and the use they are put to. The fiscal deficits can be financed through domestic borrowing, foreign borrowing or by printing money.
While excessive domestic borrowing can lead to a hardening of interest rates, too
money stokes

i ,l

rl
et us look at the various kinds of arguments made against deficits.

il

il

The monetarists argue that deficits crowd out private borrowing, :U

raise interest rates and cause inflation. So, they advocate you should
not try and stimulate the economy but, over a 5-8 year pertod, look at
a steady and sustainable increase in money supply, and economic growth N
will follow. This post-Friedman approach has been discredited after the fi- :,
nancial meltdown, sincethe whole question of money supply has fallen flat

!i

on its face. Liquidity vanished, banks failed and various federal authorities were

taken by surprise at what was happening in the world of finance capital.

If

the simplistic monetary theory has failed, we have no option but to stimulate in
the fiscal domain, which is what is happening in the US and Europe.
Which brings us to the question of how much of a fiscal stimulus is bearable. The US fiscal deficit is now likely to be 12.3 per cent of GDP in 2010
(the earlier prediction was 9- 10 per cent) ; it is 15 per cent for the UK; six
per cent for Gefmany; seven per cent for Italy, Spain and France. So how
are these countries able to live with such high
hiEh fiscal deficits?
Look at their 2009 and 2010 growth pro-

i
i

jections and that's where the answer lies. For

calendar 2009, the US economy will shrink 5.5

of

per cent, Germany 6 per cent, Italy 4.2 per cent

and so on. In 2010, the projection is that the US
will be positive, UK 1 per cent, Japan 1.2 per
cent . .. so we will have 0.5 to 2.5 per cent growth

rate policy by the central bank as the G-sec

yields act as the benchmarkrisk-free rate

inthe

: ia-the develwd w,orldibSQl0-lUit&grquth,

the fiscal deficit will be taken care of. But
doesn't
w-ay,

of the deficit is to look at

the use it is put to. The same ldVel of deficit can

have different implicatioirs, depending upon

how it is used. For instance, a fiscal deficit used
for creating infrastructure and human capital
will have a different impact than if it is used for
financing ill{argeted subsidies and wasteful recurrent expenditure. The sustainability of the
deficit will be suspect in the latter case as the
use it is being put to doesn,t augment the
ability to pay back the debt. The implications
of deficits are, therefore, contextual and need
to be accordingly analysed.

up to the 7-7,5 per cent qq4ge. The

E$ff6'm-$arrderd & Poor's. Acatransient one

DHARMAXIRTI JOSHI
Director & Principal Economist,

0",I"ff.ffi1?ri#,Tff ii11:;fil?:J:#'Hisherdefi citsrtravbe

sive high deficiis notwithstanding, strict fiscal needd at VafiOUS
:ffi?tj#trtJ:fftftS,?ffi"Jffiffi1 poinr in time, butvou
thd-fastdst-gro'*ing compon",it of cf,p i" haveto separatethe
e',?'Tgliifl

"ii,ffi"$ffi',#'ii"%#,1#,tstructuralcomponent
deficits,
especiallyif d-eficits have
dfid fein that in'
used to fund unproductive spending and, importantly, if the limits dictated by the Fiscal Responsibility and Budget Management Act (FRBM) have been breached, the
Governmentmaydowelltotake apragmatic stance. As is evident, duringa downturn, government revenues shrink and expenditures shoot up which bloats the
deficit. The reverse happens during a boom. I am ofthe view and as has also
been suggested in this year's Economic Survey, {l1e concept of
would be the
fals

oT

security, medicare and other

. . . all of these increase during a downfurn when govemment revenues are
stained. So the S&P qrgumentthat the US deficit
is not struetural is flawed. The US can't reduce unemployment benefits or increase the
age-limits for medicare so easily
how is that
any less structural? ln India's case, we havejust
increased the price of fuel, so we are trying
to tackle our structural deficit.
such social security

been

out the un-

derlying deficit, whichis anormal-yeardeficit. Thiswill also allowone to separate

the structural component of the deficit, which is usually more chronic and persistent in nature and needs to be reined in.
(The v iew s ar e p er s onal)

AMIT MITRA
Ficci

'Deficits result in higher

GDP growth and more
taxes
so they are
self-correcting, Our
deficit is less structural

thanthatofthe
so,

!\

economrc

5nd. The fact

that tndia's growth is 6.7 per

as compared to the 4.5 per cent

project-

US'
tax collections

cure

and that ensures increased demand that acts contra-cyclically. Since this
doesn't happen in India, we have tro option apart from fiscal stimulus.
Indeed, while India has a huge space to tackle deficits through disinvestment and the additional revenues guaranteed through high growth, the
west does not have this space. The developed world does not have the tools
to tackle its deficit, we do.

(astnldta Sunillain)