Fiscal policy to boost demand by 0.3% of GDP in FY23, RBI staff say

As per estimates of RBI staff, the cumulative fiscal impulse amounted to 2.7 percent of GDP in FY21 and 0.6 percent in FY22.

The Centre will continue to support demand in FY23 through the 2022 Budget even though it plans to improve its finances and lower the fiscal deficit to 6.4 percent of GDP, an article written by the Reserve Bank of India (RBI) staff has said.

According to the article, the Budget will provide a net fiscal impulse of 0.3 percent of GDP in the next financial year.

Fiscal impulse is a measure of how much fiscal policy is adding to or withdrawing demand. A positive fiscal impulse means fiscal policy is acting as a stimulus.

According to RBI staff, the budget numbers indicate "resolute strategic actions by the budgeteer to secure genuine consolidation."

"Even so, a net fiscal impulse of 0.3 percent of GDP will continue to operate till the end of 2022-23," the article said.

The article, released on March 17, has been written by members of the RBI's Department of Economic and Policy Research under the guidance of Deputy Governor Michael Patra. It does not necessarily represent the views of the central bank.

As per estimates of RBI staff, the cumulative fiscal impulse amounted to 2.7 percent of GDP in FY21 and 0.6 percent in FY22.

The Coronavirus pandemic forced governments across the world to loosen the purse strings. In India, the higher expenditure as well as a drastic reduction in revenues pushed the central government's fiscal deficit to 9.2 percent of GDP in FY21. While this is set to come down to 6.9 percent this year, the government's decision to target a rather modest reduction to 6.4 percent next year caught some by surprise.

However, RBI staff lauded the government's decision.

"Fiscal policy exits from crisis modes are much more difficult than going in; in the case of pandemics, it is excruciatingly so," the article said.

"Too rapid and large a withdrawal of fiscal support risks pushing the economy over the cliff into a sharp downturn. On the other hand, the ramp effects of too gently sloped a withdrawal runs the risk of moral hazard, and the building up of pressure groups for delaying the withdrawal of policy stimulus. The Budget for 2022-23 commences this journey of conflicting pulls by seeking to calibrate a thrust to growth with feasible rectitude."

According to calculations made by RBI staff, the benefits of the 2022 budget's "infrastructure-first strategy" will peak in FY26.

"It is now for private investment to respond and participate in the recovery," it argued.

While the fiscal deficit target for the next financial year has been set at 6.4 percent of GDP, it is to be brought down to 4.5 percent by FY26. According to the RBI staff article, consolidation of government debt after the pandemic will be mostly driven by GDP growth. Moreover, the consolidation envisaged by the Centre for FY23 "needs to be matched by the States".

"Going forward, debt reduction needs to assume prominence in the fiscal policy strategy," the article urged.