Evolution of Fiscal Policy

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This financial year, the budget (2009-10) has a fiscal deficit of 6.8 per cent of the GDP (and this does not include the fiscal deficit of the states). The fiscal deficit will be financed mainly by market borrowings of nearly Rs.400,000 cr. There have been concerns about the high fiscal deficit. The IMF, while praising India’s ability to face the global crisis, has warned that India's debt as a percentage of GDP was too high and, therefore, a sharp rise in the deficit could raise concerns about fiscal sustainability. The RBI governor too has underlined the need for returning to the path of fiscal consolidation to contain borrowing requirements. And the finance minister came out with the statement that the high fiscal deficit was not sustainable and in the fiscal responsibility and budget management document for 2009-10, the government plans to bring down the fiscal deficit to 5.5 per cent in 2010-11 and further to 4 per cent in 2011-12. Is the concern over the high fiscal deficit justified?

Though a large fiscal deficit by itself is not bad, it can affect the country’s economic growth adversely. A large fiscal deficit implies high government borrowing and high debt servicing (the total debt servicing will be 37 per cent of revenue expenditure in 2009-10), which in turn could mean a cut back in spending on critical sectors like health, education and infrastructure. This reduces growth in human and physical capital, both of which have a long-term impact on economic growth. Large public borrowing can also lead to crowding out of private investment, inflation and exchange rate fluctuations (impacting exports). However, if productive public investments increase and if public and private investments are complementary, then the negative impact of high public borrowings on private investments and economic growth may be offset.
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