Why there is no need to junk the fiscal roadmap

There is a sudden chorus for relaxing fiscal deficit targets by making more capital expenditure to support the country's huge infrastructure needs. And the call is not coming from outside but from within the government.

Those who are joining this chorus are Arvind Panagariya, an economist who is also the Vice Chairman of Niti Aayog (which replaced the Planning Commission), former RBI Governor Bimal Jalan, who heads an expenditure panel, and Chief Economic Advisor Arvind Subramanian.

The fiscal deficit target is 3.6 per cent of GDP for 2015/16 and 3 per cent for 2016/17. This year's target is 4.1 per cent, which is most likely to be achieved thanks to the proceeds from the telecom spectrum auction and disinvestment in PSUs. The idea of easing the fiscal deficit target is to support growth. Will Finance Minister Arun Jaitley take a cue and junk the fiscal roadmap?

Today, a bulk of the government's spending includes revenue expenditure such as salary of employees, interest payment on loans, subsidies, etc. The share of revenue expenditure in total expenditure is 75-80 per cent.

Capital expenditure (like building highways) is about 20-25 per cent of the total expenditure. There is not much scope to cut revenue expenditure to shift the funds for capital expenditure. You cannot cut salaries or default on loans. Any cut in subsidies will have political ramifications. So, increasing the capital expenditure will eventually result in widening of the fiscal deficit.

What are the implications of a higher fiscal deficit? A higher deficit will mean higher borrowing from the market. This will swell the government debt. The government debt, which is currently at 60 per cent of GDP, is already higher than other emerging markets like China and Russia.

A sustained higher fiscal deficit also adds to inflationary pressure, which means higher interest rates in the economy. In fact, the RBI has already stepped on the interest rate cycle as inflationary pressure has reduced over the past year. Any loosening of the deficit target at this stage will force the RBI to hold interest rates.

In its recent monetary policy review, the RBI talked about 'sustained high quality fiscal deficit'. By high quality the RBI means better targeting of subsidies towards the needy and reducing leakages, and moving the savings to public investments. "That's the high quality movement because on one hand it is about shrinking wasteful expenditure and, on the other, increasing the expenditure on creating long-term supply by, say, investing in highways, railways etc," RBI Governor Raghuram Rajan told Business Today recently. "When fiscal consolidation is of high quality, inflationary consequences are good."

A higher fiscal deficit will also invite the ire of global rating agencies that have upped the Indian rating outlook after Narendra Modi-led BJP government came to power. In September last year, S&P upgraded its India rating outlook from negative to stable. Moody's, too, has given a stable outlook, though with the lowest investment grade. So India is not out of the woods yet.

The GDP growth between 5-5.5 per cent (or revised one at 6.9-7.4 per cent) in the last two years isn't bad when compared with the rest of the world. Clearly, there is no pressing need for loosening the fiscal deficit target.