Financial Stability at the Expense of the Real Economy
Sunanda Sen is a former professor of economics at Jawaharlal Nehru University (JNU). She can be reached at firstname.lastname@example.org
The success achieved by the Indian economy, as highlighted in the central government’s recent budget, rests on four pillars: a current GDP growth rate of 7.6%, a decline in inflation (as measured by the CPI) to around 6%, record official reserves of $350 billion, and most importantly, a reduced fiscal deficit of 3.5% of GDP.
Looking beyond the official figures, one comes across reservations: First, the GDP growth, if calculated by the long-standing earlier method, would have generated a rate around 5%. Second, the stock of official reserves depends on inflows of short term and volatile capital, which may evaporate without much warning. Third, the comfortable inflation rate may also not last very long if the current lows in oil and commodity prices reverse. Finally, to come to the much-touted claim of achieving growth via financial stability with reductions in the fiscal-deficit-to-GDP ratio, the argument, as shown below, just does not stand up to scrutiny.
Let’s spell out what a reduced fiscal deficit implies for the economy. Unlike the earlier practice of meeting the deficit with money printed by the Central Bank with the consent of the government, the gap now can only be met by additional government borrowing from the capital market. Incidentally, that too is considered “harmful” in terms of what is considered as “prudent” fiscal practices, with official borrowing likely to pre-empt borrowing by private agencies.
The fiscal deficit, which is necessarily funded with market borrowing, generates fiscal liabilities—which incurs corresponding expenditures, in terms of interest payments, in the fiscal budget. In addition to reporting the fiscal deficit, the government’s budget document provides two more estimates of the deficit. Of those,the “primary deficit” is calculated by deducting interest payments from the fiscal balance. With the fiscal deficit at 3.5% of GDP 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 categories of spending in primary budget other than defence. It is little surprise that food subsidies will account for less than 0.9% of GDP.
What, then, has the budget offered for the economy in general? The adherence to a fiscal deficit target may project financial stability and a better investment climate—at least to those who have faith in the magical consequences of a smaller deficit as a curb to inflation and its conducive effects on investment. Reduced public spending may actually turn out to be a dampening factor for private investment which, in turn, will be matched by the inability of the state to instill demand by its own spending. Capital expenditure by the state and social sector spending are both 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 recognising the uncertain and depressive trends in the global economy, which could disrupt growth in the domestic economy, the budget proclaims to instill confidence in macro-economic stability and non-inflationary growth in India. The complacency is definitely over-rated, with a total absence of any proposed firewall against shocks to the economy, such as sudden withdrawal of short-term and speculative capital flows. We have been witnessing the recent turmoil in the global financial markets, such as the turbulence in the Chinese stock and currency markets. Nor is there any attempt to prepare the economy to weather further shortfalls in export earnings as may arise with global 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 markets. The Security and Exchange Board of India (SEBI) is set to launch schemes for new derivatives while allowing the insurance companies to invest in stock markets. The moves are in accord with the on-going facilitation—at an official level—of risk-taking in markets, which includes the use of derivatives like futures as hedging instruments. There is little, if any, concern on the part of the government about the spate of speculation in stocks, property, currency, and even commodities.
The economyof India today is evidently dominated by finance, which has little to do with the real economy of output and jobs. The gains and losses from derivative instruments like futures, options and swaps are transfers across the economy, which do not account for changes in GDP. There is no reason for a rise in stock market transactions which pushes up stock indices like the Sensex to be associated with a simultaneous or lagged rise in GDP in the real economy. Speculation in uncertain markets has been used to operate with shadow banking practices responsible for the growing incidence of non-performing assets (NPAs) in the public sector banks and for the large number of scams in the economy.
The budget document 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 so-called “financial stability” at the cost of the real economy?
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