A proposed fiscal strategy for a sustainable economic recovery

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A proposed fiscal strategy for a sustainable economic recovery

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• Budget 2021-22: This may well be the most challenging budget presented ever by any Indian finance minister, due to the ongoing contraction. The 'bow string' effect saw recovery after a sharp contraction in Q1 of 2020-21. RBI kept injecting liquidity, and overall, GDP may contract by upto 7.3%. 
• Effects will last long: Any economic shock can linger on and on, hence fiscal policy must prime demand to return to "trend growth path". The present recovery has come with higher inflation, higher fiscal deficit and higher yields on G-secs.
1. Public debt to GDP ratio is set to touch 90%, and debt servicing costs will reduce ability to spend on productive projects
2. Budget's priority can be kick-starting new projects, or containing deficit
3. The 'base effect' of 2020-21 means 2021-22 will see higher growth, though general govt. deficit is set to touch 14% of GDP (if contraction is 7.3%).
4. The total stimulus was RBI's liquidity infusion at 6% of GDP plus fiscal impulse at 7% of GDP (excess of FY21 deficit over FY20)
• Recommended strategy: If GDP grows at 10%, and inflation stays at 5%, then nominal GDP would grow at 15%. The govt. can then keep pushing growth while cutting deficit. The trick will be to set an expenditure target that's higher than in FY21 but a growth rate lower than expected nominal GDP growth rate.

1. Revenue buoyancy of 1 will ensure that revenues grow faster than expenditure, so deficit goes down [1 is the historic norm seen]
2. If real GDP and nominal GDP grow at 10% and 15% resp., revenues growth at 15%. If exp. grows at 12% (7% real terms), then fiscal deficit in 2021-22 will be less than in 2020-21
3. Use this strategy through a rolling 3-year medium-term strategy framework till the general govt. deficit comes to 5-6% of GDP by 2025-26
4. Summary - set expenditure in a year at higher than previous year's, but growth rates at lower than that of nominal GDP (hence revenues too)

• Growth drivers: So public expenditure drives growth for sure, but other factors matter too. RBI's liquidity infusion was important for demand stimulation in 2020-21. RBI can keep playing that role for many years. The Covid vaccines can boost growth. Economic indicators show uptick in exports and investments. To shift India onto a higher growth path, deep reforms are now needed.
• How you spend matters: The expenditure must be tailored to support income support to those who lost livelihoods. High consumption propensity of distressed households will strengthen the multiplier effect of govt. spending. One example is the PM Gram Sadak Yojana.
• Cooperative federalism: Centre state coordination in matter of spending will matter a lot, as much as on matters related to GST.

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