5 February 2014

India needs to increase public spending

Jayshree Sengupta
04 February 2014

One thing that the UPA government is trying its best to control is the fiscal deficit (the difference between government expenditure and revenues excluding the borrowings). The IMF has also warned that if the fiscal deficit is not controlled, there would be problems of high inflation and this would lead to a falling growth rate. The government seems all set to adopt austerity measures for containing the fiscal deficit but this may have an adverse impact on job creation. 

In recent times, the results of austerity measures adopted by different governments have not been very successful especially in the EU. A lesson could be learnt from the on-going Euro zone crisis which is leading to deflation and a rise in unemployment. Deflation is the opposite of inflation -- it means falling prices and higher real interest rates which lead to reduced investment and more unemployment. France has gone in for austerity measures. France's unemployment rate is high at 11 per cent and youth unemployment at a higher 25.6 per cent. Similarly, Greece and Spain, which went for austerity measures, are also faced with unemployment at 27.8 per cent and 26.7 per cent respectively with youth unemployment at nearly 60 per cent in Greece and 57.4 per cent in Spain. A situation where the young people coming out of schools and colleges cannot find jobs is hard to handle for any government. 

The US, on the other hand, has managed the aftermath of the financial crisis relatively better. The global financial crisis began in the US in December 2007 and ended a year and a half later. The US went in for monetary easing ever since to resuscitate demand and encourage economic recovery. Under its monetary easing policy, the Federal Reserve or the central bank buys bonds from the government worth $85 billion a month which means that a huge amount of liquidity is injected by it into the financial system. In this manner the US has managed to keep interest rates at the near zero level. It has also been successful in lowering the home mortgage rates. This has helped the recovery of the housing market. The US economy has seen a recovery in recent times and growth has been at 2.2 per cent which prompted the Federal Reserve to announce in June 2013 the tapering of its monetary easing policy in 2014. This created havoc in the emerging markets of Brazil, India, China, Russia, Turkey, Argentina, Indonesia and South Africa. The Indian rupee fell rather sharply. The recent turmoil in the stock markets is also due to the fear of less global liquidity. 

Clearly the US is coming out of its economic crisis and is in better shape than the EU in terms of the pace of economic recovery. The EU has had a massive bailout by the European Central Bank but the sovereign debt of some of its members is still large and growing. The US has an unemployment rate of around 7 per cent but there is a little problem of falling demand and the US recovery is poised to be stronger in 2014 which will help the rest of the world with a rise in US demand for goods and services. 

Europe, on the other hand, has had one star performer in Germany, whose exports and growth rate are rising and it has controlled inflation also. Joblessness is much less in Germany because it has managed to keep wages down and discouraged trade unions' collective bargaining. Austerity measures, on the other hand, increased poverty in the EU as pensions and health spending have been cut. Greece cut its health spending by 40 per cent. 

India, which has experienced a 4.6 per cent growth rate in 2013-14, requires higher public spending on infrastructure. More public services and goods are needed to bring relief to the lower income groups, especially health services, otherwise they are likely to slip into poverty. 

There is need for an increase in public spending in agriculture as productivity is low and farmers are burdened with both small land-holdings and low quality inputs. If irrigation too is inadequate, they are doomed to remain subsistence farmers. Increasing irrigation facilities for small farms through big and small irrigation works is imperative and state governments' spending will depend on the money they receive from the Centre. Similarly more storage and marketing facilities are needed. The Central government cannot afford to scale down its agricultural investment in infrastructure. Similarly, roads have to be built to increase connectivity between towns and villages and towns with cities. It has been proved that lack of good roads and ports is a big deterrent to increasing investment. 

The Finance Minister has announced that the fiscal deficit will be at 4.65 per cent of the GDP for the current fiscal when he presents the Vote on Account in the Lok Sabha on February 17. The Finance Ministry has slashed about 12 to 15 per cent of the funds promised for social welfare schemes and plan allocations from the Budget presented last February. Last year, the efforts to meet the fiscal deficit target led to a Rs 100,000-crore cut in the Plan expenditure. 

This year the fiscal deficit has already hit 94 per cent of the government's target. The tax revenues have also not picked up greatly due to the slowdown in economic growth. Hence a big cut in expenditure is likely. Already to meet its fiscal deficit, the government is likely to use cash reserves of 20 PSUs by seeking special dividends from them. 

If a lesson can be learnt from the EU, it is that austerity does not always work as it compresses demand and lowers industrial growth which leads to unemployment. Instead non-essential expenditures like foreign travel by ministers and bureaucrats as well as MPs should be curbed. The government can also increase the duty on gold, silver and platinum and also ban the holding of meetings and conferences in five-star hotels. Curbing consumption expenditure is more justifiable than curbing investment expenditure which would go a long way in enhancing the productive capacity of agriculture and industry. 

Yet the rating agencies and the IMF will go on insisting that cutting government expenditure is important for containing the fiscal deficit. Otherwise, there could be a downgrade of India's investment rating to below investment grade by agencies like Moody's which will create problems for corporate borrowers abroad. But economists, including the Prime Minister, agree that the need of the hour is to increase investment which is the key to the revival of manufacturing industry to create jobs. This can only happen if infrastructure is upgraded and an enabling environment is present. 

(The writer is a Senior Fellow at Observer Research Foundation, Delhi) 

Courtesy: The Tribune, February 4, 2014 

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