Part I — Modi’s fiscal masterclass
Fiscal management has been one of the most critical parameters for evaluating the central government’s economic governance as far back as I can remember — and I have been a amateur observer of the Indian economy for more than two decades. And not without reason. In the Indian context, fiscal management goes well beyond the classical approach of fiscal as a countercyclical force — i.e. government spends more during economic downturns and dials back when the economy is doing well. For India, there has been a strong case for a structural reduction in the government’s fiscal deficit primarily for the following reasons:
A) The most obvious reason — uncontrolled fiscal deficit can result in a debt trap. The Indian government has already been spending between one-third and half of its total receipts towards interest payments since 2000.
B) The fiscal deficit is funded by borrowings in the domestic market. This in turn, crowds out investment by private sector who are competing for the same funds.
C) High fiscal deficit risks macro-economic instability — high inflation and a Balance of Payments (or foreign exchange) crisis . High government spending flows into higher income for households which drives higher consumption demand. If there is not enough supply, it leads to inflation. If you think about it, it is related to B). It boils down to the fact , in many instances, government spending is not economically efficient and therefore is not generating commensurate economic output.
Indeed, we saw the macro-economic instability play out in UPA 2 as high fiscal deficit contributed to persistently high inflation, an out-of-control trade deficit (imports less exports of goods and services).
That being said, economic theory is not like the laws of physics. There are those who have argued that both During the Vajpayee and Modi years, the governments missed a trick by being too fiscally conservative and thereby stifling growth. But even most of these critics argue only about the scale of fiscal tightening, not the principle itself that fiscal tightening is a good for the long term.
As is to be expected, the ideal amount that any government would prefer to spend is…….infinite. The more a government spends, the more popular it will be with the voters, in the near term at least. Fiscal management for a ruling party, therefore is a tightrope walk between preserving one’s political capital and an economically optimal fiscal policy.
In these series of posts, I plan to analyse Modi’s record of fiscal management during his second term. I posit that Modi has delivered a masterclass in fiscal management — he has achieved the near impossible of following a disciplined fiscal policy while not just maintaining his political capital, actually expanding it. All this, amidst times of high economic turbulence globally. In good part, this is because we have, arguably the most incompetent and out-of-touch opposition since independence. But this is also a story of how a politician put his popularity at stake and took the more difficult economic path and the average voters’ willingness to look past their near term pain due to their abiding faith in the man’s intention (the Hindi word is neeyat, I think) and ability to deliver in the long-term**. That is what it is all about — because let us be honest, Modi has, after all, not delivered all that well in terms of the promise of acche din so far.
**Critics will argue this is because voters are prioritizing Hindutva over economic development. There is some truth to it as well and as a Hindutva supporter, I see it as a good thing. But I believe they are exaggerating the Hindutva factor but that is a separate debate.