Macro economics

Fiscal-Monetary Mix

             Since the V shaped recovery in 2009-10, Indian macro policy would have produced better results if the fiscal policy had been tighter and monetary policy looser and supply bottlenecks had been directly attacked through policy reform.  This remains true today.  Virmani (2003) showed that even though a rise in the fiscal deficit and a 0.5 elasticity of the Current Account deficit with respect to the central fiscal deficit caused the 1991 BOP crises, a flexible exchange rate (resulting in 30-40 per cent devaluation) would have obviated the crisis. The government could then have had sufficient time for a textbook expenditure switching-expenditure reducing policy (of the kind adopted after the crises) to work.

Fiscal Deficit

             Recent policy research suggests that the critical danger point for the government’s debt GDP ratio is between 60 per cent and 100 per cent, with the threshold being on the lower side for developing countries and on the upper side for developed countries. Large fiscal deficits and a high net international debt position make a country vulnerable to global financial shocks and terms of trade shocks (e.g. oil price spikes).  As India’s fiscal deficit is the primary reason for keeping its global credit rating perched on the border of investment grade, a total (center + states) fiscal deficit around two percent and a total Debt-GDP ratio of 40 per cent (over the next ten years) would be helpful in attaining a triple A rating and reducing dependence on unstable capital flows.  The Government’s ability to deal with Global adverse shocks and to exploit new global opportunities, while sustaining high domestic investment levels and lower inflation, would be greatly strengthened. Sustained fiscal reduction requires a return to the tax reform approach initiated in the 1990s and now represented by the Direct Tax Bill and the Goods and Service Tax.  The latter will help in creating a unified market in the country and facilitate greater competition. Government expenditure policies must also restore the balance between (a) public goods and human capital (skills, education, public health, communicable disease control) that promote equity and (b) income/ consumption transfers and subsidies that incentivize dependency.

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