In the U.S., the debt ceiling is once again making headline news. Government shutdowns and the thought of U.S. defaulting on its debt could have devastating consequences both for the U.S. and for the global economy. Meanwhile, India is a completely different story.
The Covid-19 pandemic after effects will test how much debt developing countries can bear. The attitude within OECD of course has been “don’t worry about government deficits so much and continue to spend”. Last year the U.S. Federal Reserve and other counterparts moved aggressively with sweeping emergency rate cuts and offers of cheap dollars, to help combat the pandemic. Emergency policy easing by central banks in UK, New Zealand, Japan and South Korea, Australia, too had provided further stabilization. But can non-OECD or developing countries pump ample liquidity into the markets too, and support fiscal stimulus?
Which brings me to India. India has around $540 billion FX reserves.
India’s overall fiscal deficit- the gap between expenditure and revenue for 2020-21 was 9.3 per cent GDP, a very high number which complicates the task of monetary policy. A fully discretionary fiscal policy framework will likely worsen this. India has had the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 which sets a target for the government to establish financial discipline in the economy, improve the management of public funds and reduce fiscal deficit. The FRBM has in the past incentivized the government to reduce the fiscal deficit by a percent of GDP each year, and gradually move to a position where current spending matched current revenues. The government would need to explain to Parliament any breaches of the Act. The discipline of this law was in part responsible for a significant improvement in government finances in the first decade but after the 2008 GFC, the general government’s deficit rose sharply from 4% of GDP to 8.3%. A pause in the FRBM and an expansionary budget thereafter contributed to the large increase in the deficit. Once the discipline of the FRBM was obviated, the urgency of imposing fiscal limits was no longer clear. After the stimulus, the economy did recover from April 2009 onwards, but the fiscal stimulus was not rolled back, and deficits remained high. Ever since, the government has continued to borrow. The lack of a rules-based system due to escape clauses in the FRBM has come alongside a sharp deterioration in government finances. A fiscal rule spending rule would increase the accountability and transparency of fiscal policy. A rule could be a variant of an “Expenditure Rule, or Revenue Rule, or Budget Balance Rule or a limit on Debt Rule”.
Of course, implementing any such fiscal rule would be much more difficult, as it involves the government and opposition coming together on spending issues.
But shouldn’t India have fiscal rules that outline its fiscal policy?