Chidu Vs Panagariya on fiscal deficit: why the ex-FM's argument has no merit

Arvind Panagariya, a Columbia professor and economist who is widely tipped to have a key policy-making role in the Modi government, has said that it would not be wrong to retain a higher fiscal deficit to revive growth. The fiscal deficit is the gap between government expenses and revenues which need to be bridged by borrowings.

Panagariya told Reuters last week: “In an economy where you are trying to push up the growth rate, a fiscal deficit of 4.5 percent (of GDP) is fine.” This is the actual fiscal deficit reported in 2013-14, and retaining it at the same level would thus mean no further correction this year.

The previous finance minister, P Chidambaram, disagrees, and says that the Modi government shouldn’t take Panagariya’s advice. Speaking after the monetary policy was announced today (3 June) Chidambaram said: “Will the government follow the Kelkar recommended path and affirm the budget estimate fiscal deficit of 4.1 percent for 2014-15? Or will the government take the advice of ArvindPanagariya (wrong advice in my view) and allow the fiscal deficit to rise? This is the million dollar question.” Chidambaram believes that the Modi government should build “upon what has been achieved”

The question is: What really has been achieved? And how? It is worth carrying on from where Chidambaram left off if he has left things in a bit of a mess?

This, unfortunately, is the case.

First, the 4.5 percent fiscal deficit achieved in 2013-14 has been achieved with the most dodgy book-keeping ever done by an Indian finance minister. The real deficit is much higher, and thus there is no way the real fiscal deficit can be pushed down to 4.1 percent in 2014-15 without causing a deeper slowdown. This will be specially true if the books are cleaned up by Arun Jaitley and the actual fiscal deficit is shown to be higher than 4.5 percent..

Second, the sharp cut in last year’s fiscal deficit has been achieved by cutting the wrong kind of costs. Chidambaram cut capital and investment spending, not wasteful subsidies. This has worsened the slowdown, and not improved the climate for a revival. This is clearly not the path for any finance minister to follow.

Third, Chidambaram says he wants the fiscal roadmap drawn up by Vijay Kelkar to be respected. But he didn’t do any such thing when he was finance minister. He announced changes in the fiscal roadmap as soon as he became finance minister in UPA-1 in 2004, and again changed it when he presented the last budget of UPA-1 in 2008, when he had to finance all his election-eve giveaways.

This is what he said in his 2008-09 budget speech: “In the case of revenue deficit, I will meet the target of annual reduction of 0.5 percent. However, because of the conscious shift in expenditure in favour of health, education and the social sector, we may need one more year to eliminate the revenue deficit. In my view, this is an entirely acceptable deferment.”

Why is this an “entirely acceptable deferment” when he decides it, but not if Arun Jaitley or Arvind Panagariya say so? And remember, when Panagariya says let the deficit be 4.5 percent, he wants the deficit targets maintained in order to shift expenses from consumption to investment, not to offer loan waivers and increase subsidies.

If the new government maintains the fiscal deficit target at 4.5 percent or 4.6 percent after restating Chidambaram’s fictitious accounts and after shifting expenses from consumption to investment, it is an entirely worthwhile exercise. It would amount to real fiscal correction and improve the economy, and thus set off a virtuous cycle of higher growth driving higher revenues - and lowering the fiscal deficit in due course.

As we have noted before, the real fiscal deficit minus Chidambaram’s accounting legerdemain was probably well above 5 percent in 2013-14 - and restating this does not amount to any relaxation in the actual fiscal deficit target.

The truth is Chidambaram’s fiscal roadmap was heading in the wrong direction based on wrong calculations. Even his last act as FM was intended to hide the deficit somewhere else. Changing it to something sensible and believable would make it a more credible roadmap, real reform.

Panagariya is right, and Chidambaram is just talking sour grapes here.