Will Rs 1,00,000 crore budget cuts revive GDP? Jaitley should abandon Chidu's fiscal fundamentalism

The government’s mid-year economic review talks of anaemic growth of just around 5.5 percent of GDP this year, which will be better than the UPA’s sub-5 percent growth in 2012-13 and 2013-14, but simply not good enough.

In fact, actual GDP figures could be lower if the government’s ambitious disinvestment target of over Rs 63,000 crore is missed, and Finance Minister Arun Jaitley is forced to cut plan and non-plan expenditure drastically to meet his fiscal deficit target of 4.1 percent in 2014-15.

Business Standard reports today (19 December) that government expenditures may have to be slashed by as much as Rs 1,00,000-1,20,000 crore this year due to a shortfall in tax and disinvestment revenues, despite a fall in the subsidy bill due to falling global oil prices and delays in the rollout of the Food Security Act.

If this is the case, for Jaitley to say he will stick to his fiscal deficit target of 4.1 percent is suicidal. He should let it slip to, say, 4.5 percent, which is what well-wishers of this government, like economist Arvind Panagariya, had advised in the first place. You cannot revive growth by cutting investment expenditure, though there is no harm cutting non-merit subsidies in oil and fertilisers.

In June, before Jaitley presented the NDA’s first budget, Panagariya had advised easing up on the fiscal deficit roadmap decided by P Chidambaram. “In an economy where you are trying to push up the growth rate, a fiscal deficit of 4.5 percent (of GDP) is fine,” Panagariya had said . Chidambaram immediately jumped in to criticise Panagariya.

Jaitley, unfortunately, chose to ignore his well-wisher and got psyched by his political rival’s fiscal goals. In his budget, Jaitley, while noting that “the target of 4.1 percent fiscal deficit is indeed daunting,” he had decided to decided to accept this target as a challenge. One fails only when one stops trying. My road map for fiscal consolidation is a fiscal deficit of 3.6 percent for 2015-16 and 3 percent for 2016-17. "

Jaitley is now making good on a promise that can only bring short-term grief. A Rs 1,00,000 crore cut in expenditures this year will devastate growth as it comes on top of two years of large cuts of the magnitude of Rs 79,636 crore (in 2012-13), and Rs 1,02,000 crore in 2013-14.

Add this year’s proposed cut of Rs 1,00,000 crore in the next three months, and it will mean in three years government expenses - most of it plan expenditure rather than wasteful subsidies - will have been cut by an aggregate of over Rs 2,80,000 crore. Little wonder, the economy is not growing.

When private investment is not picking up, cutting government expenditures by such large volumes can only reduce growth further.

It is time for Jaitley to abandon Chidambaram’s fiscal fundamentalism. This means he should not be wedded to cutting the fiscal deficit by any means, but must focus on cutting only those areas that do nothing for growth - like subsidies or wasteful expenditures. He must cut flab, not muscle.

Rather than set fiscal deficit targets of 3.6 percent and 3 percent of GDP for the next two years, he should set revenue deficit targets of, say, 2 percent and 1.5 percent of GDP as the main goals. (In 2014-15, the budgeted revenue deficit target is 2.9 percent). Bringing the revenue deficit to zero in three or even four years is more important than bringing the fiscal deficit down drastically in the midst of an economic slowdown. Jaitley’s budget had pegged the revenue deficit (at Rs 3,78,348 crore) at 71 percent of the fiscal deficit (Rs 5,31,177 crore).

What is truly inflationary and disastrous is the revenue deficit, which is broadly equivalent to living beyond your means; what is suicidal is to cut productive investments (plan and capital spending, which are the easier bits to cut for any FM), which improve the productive capacities of the economy.

When Jaitley had presented his budget in July, he had projected 13.4 percent growth in GDP (at current prices), assuming higher levels of inflation. Now that inflation is down and the real GDP growth expectation is only 5.5 percent, the overall GDP (at current prices) may not grow by more than 10 percent (5.5 percent real growth plus around 4.5 percent inflation).

The shrinkage of GDP growth in current terms from the 13.4 percent level envisaged in the budget implies revenue shrinkage. In this situation, to be tied to a very sharp cut in the fiscal deficit means the government is facilitating a further slowdown at a time when the economy is anyway sluggish after three years of spending cuts of the wrong kind.

In this scenario, it actually makes sense to throw the bookish knowledge on fiscal deficits out of the window and maintain government expenditures at budgeted levels, never mind the miss in the fiscal deficit target. Government spending must act counter-cyclically till private investment picks up the slack. Especially when interest rates are not going to come down in a hurry.

Chidambaram’s fiscal fundamentalism has been a major contributor to the continuing slowdown. Arun Jaitley must rework his fiscal deficit roadmap by shifting the focus to revenue deficit. Once this is fixed, fiscal deficit will follow.

Jaitley should not put the fiscal deficit cart before the revenue deficit horse if he wants the economy to revive.