In a tantalising hint at the kind of stance the upcoming budget might take, the 2020-21 Economic Survey called for a fiscal expansion, and supported a "more active, counter-cyclical fiscal policy" at a time of economic slowdown, like the current COVID-19 induced one.
The survey, drafted by Chief Economic Advisor Krishnamurthy Subramanian and his team, said that a fiscal policy that provides an impetus to growth will lead to lower, not higher, debt-to-GDP ratios.
"While acknowledging the counterargument from critics that governments may have a natural proclivity to spend, the Survey endeavours to provide the intellectual anchor for the government to be more relaxed about debt and fiscal spending during a growth slowdown or an economic crisis," the survey said.
These observations in the survey come just days before Finance Minister Nirmala Sitharaman presents the Union Budget 2021-22, in which she is expected to announce a fiscal expansion. For 2020-21 the budgeted fiscal deficit target was 3.5 percent of GDP. However, the pandemic put paid to that. Now, from an expected fiscal deficit of 7-8 percent of gross domestic product in 2020-21, the Centre may follow a glide path which will bring down the budget deficit to 4 percent of GDP by 2025-26.
“The Survey's call for a more active, counter-cyclical fiscal policy is not a call for fiscal irresponsibility," the survey added. A pro-cyclical fiscal policy is when the government spends more or gives more tax benefits during boom years but cuts back during a slowdown. A counter-cyclical policy is when a government spends more or provides tax relief during a slowdown.
“In a recessionary year, Government must spend more than during expansionary times. Such counter-cyclical fiscal policy stabilizes the business cycle by being contractionary in good times and expansionary in bad times,” the survey said.
The survey said that the biggest argument against a counter-cyclical policy is that it leads to an increase in debt to GDP ratio. However, it added that since the underlying GDP increases due to higher public spending, that argument may not hold.
“For India and other emerging markets which have consistently grown their GDP at high rates over the last few decades, the relationship between debt and growth exhibits a clear direction of causality: Higher growth lowers debt-to-GDP ratios but lower debt does not necessarily lead to higher growth,” it said.
A higher fiscal deficit means the need to borrow more, for any government.
“For emerging economies such as India, an increase in public expenditure in areas that boost private sector’s propensities to save and invest, may enable private investment rather than crowding it out,” it said.During economic crises, a well-designed expansionary fiscal policy stance can boost potential growth with multi-year public investment packages that raise productivity. The multi-year nature of public investment would contribute to credibly lifting growth expectations, it said.