Fiscal consolidation measures may avert downgrade but may hurt economy further

MUMBAI: The government’s efforts at fiscal consolidation, while helping avert a sovereign downgrade, may risk slowing an economy already grappling with growth rate at its lowest in nearly a decade. Nomura Securities has estimated the economy may grow 30 to 40 basis points less than the initial forecasts of 5.3% for the quarter ended December and 5.9% for the quarter ended March. “Ceteris paribus (other things remaining unchanged), the ongoing fiscal consolidation suggests that GDP growth could be 30-50 bps lower than our current forecasts,” said a report by Sonal Varma and Aman Mohunta.

The Reserve Bank has estimated the short-run fiscal multiplier at 0.55 and the long-run fiscal multiplier at 0.27. Fiscal multiplier, the ratio of change in growth in the economy or GDP to the aggregate government expenditure of state and central governments combined, assesses the impact of a change in government expenditure on the country’s economic growth. A multiplier less than 1 suggests that a cut in government expenditure leads to less than proportionate change in GDP. But the impact is more in the short run than in the long run as is evident from the multiplier numbers. “In the medium term, fiscal consolidation would support the economy, but near-term growth prospects could be hurt if the quantity of fiscal adjustment comes at the expense of good-quality spending,” said a report by Taimur Baig and Kaushik Das of Deutsche Bank.

Data shows the fiscal consolidation is happening largely by cutting capital or by developmental expenditure. While revenue expenditure rose 10.7% during April-December 2012, as budgeted, capital expenditure rose only 9.6% against the budgeted 30%. “Lower public investment in crucial infrastructure would have implications for growth,” the RBI has said. It has cautioned that fiscal augmentation through increased recourse to disinvestment proceeds and one-off receipts such as spectrum auctions may not be sustainable.