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Mainstream, Vol XLVII, No 32, July 25, 2009

Union Budget 2009-10: Quality of Fiscal Deficit

Monday 27 July 2009, by Bharat Jhunjhunwala

Finance Minister Pranab Mukherjee has relied on increase in fiscal deficit to break the recession. The fiscal deficit was about 3 per cent of our national income two years ago. It increased to 6.2 per cent in the last year, 2008-09. Now Pranab Mukherjee has proposed to increase it to 6.8 per cent for the coming year.

Expenditures in excess of income of the government are called fiscal deficit. The government has the authority to print notes or borrow from the public or foreign countries in any quantity and incur expenditures greater than its revenues. Such increase in expenditures leads to price rise. Say, 10 kg of wheat is lying in the market to be sold. Private purchasers have Rs 100 in their hands to buy this. The price of wheat is then settled at Rs 10 per kg and the wheat is sold. Now, the government prints notes worth Rs 50. As a result Rs 150 start chasing the 10 kg of wheat and the price increases to Rs 15 per kg. More importantly, the private people are put to a loss. The Rs 100 in their hands now buys only 7 kg of wheat instead of 10 kg previously. In this way, fiscal deficit transfers purchasing power from the public to the government.

Private expenditures are generally considered better than government expenditures because the latter has a huge problem of leakages. Say, for example, the government prints notes worth Rs 50 and the Minister deposits the money in a Swiss bank. Now the Swiss Bank will lend the money to some buyer who will buy goods from India and take it to Europe. This would be highly harmful for our economy. Thus, it is considered good to keep fiscal deficit in check.

A different policy is suitable under conditions of recession, however. Say, the public is afraid of an impending recession and is unwilling to buy goods from the market. It is more inclined to save its incomes for possible bad times in future. In such situation, goods may lie unsold in the market because people are unwilling to spend. This leads to recession. In such circumstance it is acceptable to increase government expenditures much like a patient is given tonic to jumpstart his digestive system. The increase in demand from the government starts a cycle of consumption, purchase and production. In the light of the above discussion, I feel that fiscal deficit is justified if the quality of government expenditures is good and if this is resorted to for a short period in exceptional circumstances.

The Budget presented by Pranab Mukherjee does not fare very well on the touchstone of quality. Government expenditures can be classified in four categories. The lowest category is that of government consumption. Bigger pay packages given to government employees under the Sixth Pay Commission are of this type. Consumption needs of government employees are mostly already fulfilled. They will mostly buy gold from the additional incomes and this money will find its way to South Africa. The impact on the domestic economy will be like that of sedatives. The second category of expenditures is that towards the NREGA and food subsidies. These are of medium quality. The poor mostly spend the Rs 100 wage received by them from the NREGA. Consumption by the poor increases as a result. A fortuitous cycle of increased consumption, demand and production is initiated. The third category of expenditures is investment in capital-intensive infrastructures such as highways. These too are of medium quality. Such expenditures lead to higher demand for steel and cement. Also the highway acts as a lubricant for the economy. But these are not so beneficial for the common man. The fourth category of expenditures is investment in labour-intensive infrastructure. The government can give labour vouchers to departments like PWD, irrigation, forest and highways. This will lead to a spontaneous increase in the budget of these departments. It will become attractive for them to use labour to dig foundations instead of employing excavators because labour vouchers are available for free. This policy is the best in my reckoning. This will be pro-people, it will generate a cycle of consumption, demand and production, and it will provide lubricant to the economy in the infrastructure that is made.

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Mukherjee has increased expenditures in the lower three categories. More money is provided to government employees under the Sixth Pay Commission. More money is allocated to the NREGA and also capital-intensive infrastructure. But there is absence of expenditures on labour-intensive infrastructure. Indeed, increased expen-ditures on the NREGA fall into this category somewhat. But the scope for making truly productive rural infrastructure is limited. It is harmful to build a four-lane cemented highway to the village. Therefore, the increases in expenditures that have been proposed by Mukherjee are of low-medium quality. A fortuitous cycle of consumption, demand and production will be established only minimally. Government employees will buy gold, useless works will be undertaken under the NREGA and leakage will deplete the expenditures made on infrastructure. Mukherjee would do well to move to the best category of expenditures by giving labour vouchers to investment-oriented line departments.

The second point of assessment of the fiscal deficit is whether it is like a tonic or staple food. The underlying question is whether the present global recession will be short or prolonged. Increased government expenditures will act as a tonic only if the recession is short. They will act as a sedative and pull down the economy if the recession is prolonged. Mukherjee believes the global recession will be short. I think otherwise. The main cause of the recession is that new technologies are not being created in the Western countries which they could sell to us at high prices. They are unable to compete with India and China in goods like clothing, car and football. Therefore, I suspect the economic condition of the developed countries will deteriorate and global recession will worsen. The fiscal deficit will become a curse in this situation. Money provided to government employees under the Sixth Pay Commission will find its way to South Africa for the purchase of gold. Money allocated to the NREGA will be wasted in making useless check dams and re-digging the ponds where there is no water. Investment made in highways will not repay itself in absence of demand to ferry containers to the ports for export.

Former Economic Advisor Shankar Acharya writes:

The bulk of the massive expenditure increase is due to interest payments, defense, subsidies, salaries and pensions, and major social programmes such as NREGA and Bharat Nirman. The notion of a temporary fiscal stimulus assumes that it can be readily reversed when the need for the stimulus goes. None of the expenditure categories mentioned above looks very reversible to me.

This writer agrees. The quality of expenditures in-built into the fiscal deficit is poor. Yet, it will have a good impact if the global recession is short.

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