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Budget’s exercise to achieve financial stability at cost of real economy in India

By Sunanda Sen* (Guest Blogger)

Success achieved by the Indian economy , as highlighted in the recent budget of the central government rests on four pillars which include current GDP growth rate at 7.6%, drop in inflation ( as measured by the CPI index) around 6%, a record stock of official reserve at $350bn and most importantly, a reduced fiscal deficit at 3.5% of current GDP.

Looking beyond the official figures to convey the positive note, one comes across reservations; first that the GDP growth, calculated by the earlier method so long followed, would have generates a rate around 5% and no more. Second that the stock of official reserves have much to do with inflows of short term and volatile capital flows which may evaporate without much warnings. Third the comfortable inflation at present may also not last very long if the current lows in oil and commodity prices reverse. Finally, to come to the much proclaimed claim of achieving growth via financial stability with reductions in the ratio of fiscal deficit to the GDP , the argument. as pointed out below, does not stand scrutiny.

Lets spell out what a reduced fiscal deficit implies for the economy. Unlike the earlier practice of meeting the deficit with money printed by the Reserve Bank with the consent of the government, the gap now can only be met by additional borrowings of the state from the capital market. Incidentally, that too is considered ‘harmful’ in terms of what is considered as ‘prudent’ fiscal practices, with state borrowings likely to preempt borrowings by private agencies.

As for the fiscal deficit which is necessarily funded with market borrowings, it simultaneously generates fiscal liabilities in terms of interest payments which incurs corresponding expenditures in the fiscal budget . In addition to the fiscal deficit, the budget document provides two more estimates of the deficit. Of the latter the ‘primary deficit ‘ is arrived at by deducting interest payments from the fiscal balance. With the fiscal deficit at 3.5% and interest payments alone accounting for 3.3% of GDP , the estimated primary deficit comes to less than 0.3% of GDP. This, going by the major heads of expenditure in the primary budget, would imply cuts in social sector spending and capital expenditure, the two major heads of spending in primary budget other than defense. It is little surprise that subsidies on food accounting the budget at less than 0.9% of GDP.

What, then the budget has offered for the economy in general? The adherence to fiscal deficit target may project financial stability and a better investment climate to those who have faith in the magical consequences of a smaller deficit as a curb to inflation and its conducive effects on investment. It is. However, another matter that reduced public spending as goes with cuts in fiscal deficit may actually turn out to be a dampening factor for investment. Above will be matched by the inability of the state to instill demand by its own spending, as capital expenditure and social sector spending both of which are potentially income generating, and in addition, redistributive, an aspect which is crucial in the context of the prevailing inequality and poverty in the country.

While recognizing the uncertain as well as the depressive trends in the global economy which could disrupt a smooth sailing of the domestic economy, the budget seeks to instill confidence by taking comfort in what it observes as a path of macro-economic stability in India by achieving a pace of non-inflationary growth. The complacency is definitely over-rated, with a total absence of any proposed firewall to counter the current and future shocks to the economy as may arise from a sudden withdrawal of speculative and short term capital flows , as for example has been the case with recent turmoils in the global financial markets with the turbulence in the Chinese stock and currency market. Nor is there any attempt to prepare the economy to weather further shortfalls in export earnings as may arise with recession as well as protectionism in the global economy.

Thus it may look rather disconcerting that notwithstanding the problems with the vagaries of global finance, the budget announces further opening of financial market with schemes for new derivatives to be launched by the Security and Exchange Board of India (SEBI) and options for insurance companies to invest in stock markets. The moves are in accord with the on-going facilitation at an official level to risk taking in markets, which include the use of derivatives like futures as hedging instruments . Little, if any concern is there on part of the government to arrest the spate of speculation in stocks, property , currency and even in commodities.

The economy today is much dominated by finance which has little to do with the real economy of output and jobs . With uncertain markets generating the need to hedge financial assets by using derivative instruments like futures, options and swaps , the gains and losses therefrom are like transfers across the economy which do not account for changes the GDP. A rise in stock market transactions which pushes up stock indices like the Sensex thus has no reason to be associated with simultaneous or a lagged response with a rising GDP in the real economy. Speculation in uncertain markets of the economy has been used to operate with shadow banking practices much of which are responsible for the growing incidence of NPAs in the PSUs and the large number of scams in the economy.

The budget is remarkably tolerant of those developments, as can be gathered by its enthusiasm in further opening the floodgates of speculation in the economy. Nor is it preparing the economy against job losses in the event of further shortfalls exports which may be at the corner.

Do we then brand the recent budget as one more attempt to achieve the so-called ‘financial stability’ at the cost of the real economy?


* Sunanda Sen is a former professor of economics at Jawaharlal Nehru University (JNU). She can be reached at


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