Budget 2016: Basic imperative is to step up investment

Should the government defer fiscal consolidation further or stick to its schedule and compress the fiscal deficit to 3.5% of GDP in the forthcoming Budget? Even the framing of the question in this manner makes assumptions that do not hold in the economy at present. ‘Fiscal consolidation’ comes across as a virtue, because its absence is normally associated with macroeconomic imbalance. But the current conditions are not normal. The world economy is in torpor. India’s internal investment story is not even sound and fury, if you leave aside some e-commerce firms. Credit grows at a snail’s pace. Spare capacity exists in most consumer goods sectors, obviating investment. Infrastructure investment is hostage to debt-crippled firms. The state sector has to act to boost investment. That is the basic macroeconomic imperative.

Why is a fiscal deficit not desirable in normal times? Because it makes a demand on private sector savings that competes with the private sector’s own demand to finance its investment, leading to excess demand that spills over as inflation and a wider current account deficit. In a situation in which the private sector’s own investment demand is tepid to cold, there is little danger of public borrowings competing with private borrowings for the same quantum of private savings. On the other hand, if state sector investment generates new demand, it could crowd in fresh private investment to meet that demand. In other words, a fiscal deficit that boosts investment at a time when the private sector is chary of investing is a virtue, not a sin.

This is not to say that the government should not try harder to cut back on wasteful subsidies, by employing direct benefit transfer wherever possible, or to raise additional resources by widening the tax base and administering taxes better. Nor should any effort be spared to get additional chunks of surplus global savings into the National Infrastructure Investment In India Fund that would invest in India’s infrastructure. India cannot allow rating agencies to dictate its policy priorities that is all.