The Reserve Bank of India on Tuesday left key policy rates unchanged while it awaits further data on inflation levels and the unveiling of the Union Budget scheduled for the end of February. The central bank’s main policy instrument, the repo rate, which is the rate at which the RBI lends money to the banks, remains unchanged at 6.75 percent. Meanwhile, the cash reserve ratio (CRR), which is the portion of deposits to be kept with the RBI stands at 4 percent. Suffice to say, the central bank’s announcement on Tuesday was not unexpected. During a lecture in the national capital last week, RBI Governor Raghuram Rajan had urged the government to stick with the fiscal consolidation roadmap in the run-up to the Union Budget. He fears that in its bid to propel economic growth, the NDA government seems set on increasing public expenditure without paying heed to the potential impact it could have on the fiscal deficit and inflation. “Some say that fiscal expansion is necessary to generate the growth needed to put our debt-to-GDP ratio back on a sustainable path. This is a novel argument. Ordinarily one would think that a government should borrow less, that is, run lower fiscal deficits, in order to reduce its debt. But there is indeed a theoretical possibility that the growth generated by the fiscal expansion is so great as to outweigh the additional debt that is taken on. Unfortunately, the growth multipliers on government spending at this juncture are likely to be much smaller, so more spending will probably hurt debt dynamics. Put differently, it is worth asking if there really are very high return investments that we are foregoing by staying on the consolidation path,” Rajan said. The central bank’s policy statement reiterated the same sentiment. “Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth while also ensuring that inflation remains on the projected path of 5 percent by the end of 2016-17,” it said. The emphasis, quite naturally, is on “controlling spending”.
In a time of lower nominal gross domestic growth, higher demand for expenditure on account of implementation of the one-rank-one-pension for armed forces and the Seventh Pay Commission, the government has little wiggle room to maintain fiscal discipline. In fact, Union Finance Minister Arun Jaitley has reportedly been advised to increase the government’s fiscal deficit target to 3.7 or 3.9 percent of gross domestic product (GDP) from 3.5 percent. Other things remaining the same, if the government drastically moves away from its path of fiscal consolidation, inflation could rise significantly. The question, however, is on the quality of public expenditure. On this front, the Centre has argued that increasing public investment will significantly contribute to demand and in increasing the economy’s long-term supply potential. The NDA government has made a concerted effort to increase public expenditure through various large-scale infrastructure projects. However, structural concerns remain. Raising resources for infrastructure development projects is a real problem for both the government and corporate India. Stressed assets have remained a drag for the infrastructure sector with non-recovery of loans from the sector hitting completion of ongoing projects and investment in new projects. For its part, the government has tried to address this problem through legislation. But at this juncture, it is hard to gauge which path the economy should take. The arguments posed by both the RBI Governor and the Centre have their merits and demerits and it would be prudent to wait for the Union Budget and the quality of public expenditure it seeks to propel before we arrive at a judgment.