What is fiscal policy?
Fiscal policy refers to set of policies pertaining to revenue and expenditure policies of the government to achieve growth and price stability as well as fiscal health. Fiscal policy is made by the finance ministry of the government while monetary policy is the domain of the Reserve Bank of India. The two policies need to hand in hand to achieve their prime objectives of growth and price stability. Today there is an interface between the government and the RBI through monetary policy committee. The main task of the RBI is today to achieve inflation targets by monetary management— management of rate of interest and credit expansion. Fiscal policy can be expansionary or contractionary depending upon the need of an economy- an expansionary policy is required when economy is passing through the downside of the business cycle, i.e. recession whereas contractionary fiscal policy is adopted on the rising part of business cycle that is boom or inflation.
Short term fiscal policy is reflected in the budgetary policies of a particular year. Mid- term fiscal policy takes into considerations public revenue, expenditure and fiscal health related policies for next 3-5 years. On the other hand long term fiscal policy takes into consideration a longer period, say 10-15 years. The economic survey 2015-16 has given some ideas about short and medium terms.
The rising debate to adopt a counter-cyclic fiscal policy
In India there is a rising debate that India should quit its conventional approach which increases public expenditure on the rising arm of business cycle because during such periods government has more wherewithal for increasing public expenditure due to increasing tax collection in boom time. In conventional fiscal policy, public expenditure declines due to reduction in government revenue. The economic survey points out that India must rethink its fiscal policy in the present times when Indian economy is integrated with the global economy through trade and investment channels. When there is recession or financial crisis in one part of the world, it has adverse effect on growth of the Indian economy. In such a situation, it seems apt to follow a counter-cyclic fiscal policy rather than a pro-cyclic or conventional fiscal policy. In the times of recession the government is expected to increase its public expenditure and reduce the taxes to increase domestic demand and spur business activities.
Reforms in budgetary policies
The Union Budget for 2017-18 introduced a number of procedural reforms. First, discontinuing the practice since 1924, the Railway Budget was integrated with the Union Budget, bringing railway finances to the mainstream. Second, the date of the Union Budget was advanced to February 1, almost by a month, to help ministries and State governments plan and spend their full budget from the beginning of the financial year, whereas previously they had to wait till well into the financial year (typically end-May) for the Budget to secure legislative passage. Third, the classification of expenditure into ‘plan’ and ‘non-plan’ was eliminated to allow focus on the more economically meaningful capital-revenue distinction. Fourth, the Medium Term Expenditure Framework Statement was restructured to give projected expenditures (revenue and capital) for each demand for the next two financial years.
Introduction of goods and service tax
Overshadowing these otherwise significant fiscal policy initiatives is the introduction of the Goods and Services Tax with effect from the 1st day of July 2017, encompassing a plethora of the Central and State level indirect taxes, paving the way for a dramatic transformation of the Indian markets and the economy.
On fiscal consolidation
The budget for 2017-18 opted for a gradual consolidation. Thus, the fiscal deficit is expected to decline to 3.2 percent of GDP in 2017-18 compared with the outcome of 3.5 percent of GDP in 2016-17. The consolidation path adopted by the Central Government prudently balanced competing objectives. On the one hand, there were the requirements of a cyclically weakening economy, afflicted by the Twin Balance Sheet and manifested in declining investment and credit growth, arguing for counter-cyclical policy. And, on the other, the imperatives ofmaintaining credibility, especially in the wake of potential disruptions to state government finances, warranted adherence to a path of consolidation.
The Budget for 2017-18 assumed a moderation in indirect tax revenue growth, possibly for two reasons. There are no significant measures for additional resource mobilization in the current year. This, and the expected transition to the GST regime, explains the more conservative budget numbers in excise duties and service tax, and broadly in indirect taxes, for the current fiscal. In the aftermath of demonetisation, direct taxes are budgeted to achieve greater momentum. The compulsions of the recommendations of the 7th Pay Commission made it difficult to compress revenue expenditure significantly.
The fiscal deficit target of 3 per cent of GDP under the FRBM framework is projected to be achieved in 2018-19. The deficit consolidation plan also implies a reduction in the outstanding liabilities of the Central Government by almost 2 percentage points in each of the next three years starting 2017-18.
Fiscal Roadmap and incentives for states
As per the fiscal roadmap rolled out by FFC for the States, the States that have zero revenue deficit and fiscal deficit within 3 per cent of GSDP have additional borrowing options upto 0.5 per cent of GSDP, over and above the normal 3 per cent limit, subject to conditions. The fiscal space of the State Governments to implement the loan waiver is examined in Box 3. The implementation of farm loan waiver by different States of different magnitudes may do well to operate within these limits to ensure that the debt sustainability of the general government is not compromised.
Reforms in fiscal policy or for that matter in any other economic policies initially disturb the status quo. Implementation of demonetisation and GST would have some destabilizing effects and throw some complex challenges in front of the economy. However, the GST experience of the OECD countries shows that in the medium and long run GST is beneficial for all the stake holders—government, producers and consumers. As far as public expenditure is considered it needs to increase because falling private sector investment consequent upon the twin balance sheet problem and low expectations. This would certainly put additional challenge to the goal of fiscal consolidation. However, increase in wages and salaries due to the seventh pay commission would not only increase burden on the exchequer, but it would also spur domestic demand for durables and non-durables and that in turn would spur investment. Let’s hope for the best. Who has seen the future, but India’s dice has been casted well, no doubt except the time and method of demonitisation which would certainly be a constraint in GDP growth for the next 2-3 years. Fiscal policy would have to face this challenge.