Fiscal prudence versus Fiscal deficit

In a country like India with mixed economy, government plays a major role in economy from investment to making availability of social goods and from running social benefit programmes to supporting the less developed market of certain goods. The recent debate on fiscal discipline versus fiscal expenditure is important because of this role of government in economy and state of Indian economy over last four years.

The first question that comes to mind is what is fiscal discipline. Fiscal discipline is phenomenon where government try to limit its expenditure to the extent it earns from tax, disinvestment and others. Or if there is excess expenditure, it must be controllable (regarding payment of interest) and justifiable (stimulus during recession or capital building).

 In absence of fiscal discipline, government used to have less room for spending during crisis situation. Also, it would be difficult for government to borrow from international markets (because of poor rating which depend upon fiscal numbers), huge interest to be paid to borrowers and adverse impact on exchange rate  causing low export numbers.  The high exchange rate is a result of high interest rate which would be a result of crowding out phenomenon by government borrowing. Amidst this, fiscal discipline is important and necessary.

But, at the same time fiscal deficit is also important. For a developing country like India, the resources available to the government are often not enough to spend on capital building as well as running social benefit programmes. Under such situation, it is advisable to borrow from market (both national and international) to spend on productive work.

If not, it would take a long time for the nation to come out of poverty, unemployment and malnutrition (prevalent problem of developing economy). Also, going by Keynesian thought fiscal deficit is justifiable if used to augment business activities either during depression or through infrastructure building.

Indian economy which has seen 8-9% growth rate in pre 2008 has declined to below 5% growth rate in 2012-14 (excluding the change in base year, recently done). Amidst this low growth, there was the change of government at the centre in mid 2014. At the time, government was reeling under high deficit of 4.9% of GDP in 2012-13 and 4.5% in 2013-14. This was definitely far beyond comfort level of 3% as specified in FRBM Act . Rather, the main problem is regarding the use of this deficit causing money which was spent heavily on subsidies and less on capital building. And subsidies in India has been very poorly targeted with leaking organizations like TPDS, MSP, Fertilizer subsidy ill targeted.

As a result of high deficit, there was less capital available to private sector leading to slowdown in business activities. Further, government itself has not been spending on capital expenditure, causing infrastructure bottlenecks. And worst of all, more money is available to the people without increase in business activities and production causing inflation.

But in the recent past, fiscal status has been improved with prudential expenditure and reduced international oil price. Now the conflicting point is that to go either for fiscal consolidation through reduced expenditure or go for fiscal expansion with stress on building infrastructure to support production. The resulting fiscal expansion if used judiciously will be cyclical in nature and not structural, but it purely depends upon the intention of the ruling party. Or else, go for fiscal consolidation but  then infrastructural bottlenecks need to be overcome through private players (which in present situation, not capable enough).