True fiscal responsibility


Slashing public expenditure amid a recession is a recipe for serious economic disaster

The National Statistical Office (NSO) recently announced estimates of economic activity in the second quarter of the current financial year. As most of the first quarter coincided with the lockdown announced by the Central government, it would only have been expected that output would be depressed as production could not have taken place. And this is what happened. The GDP contracted by 23.9% in that quarter (compared to the same quarter of the previous year). However, there was no particular reason for assuming that we would see a contraction in the second quarter as well, but that is what we now find. Though the contraction has been less than both what it was in the previous quarter and what several sources had forecast, at 7.5%, it is still significant. Thus far, we have not had the V-shaped recovery predicted by the government’s economists.

To have assumed a V-shaped recovery following the lifting of the Centre’s lockdown would not have been wrong if output were determined entirely from the supply side under normal circumstances. Following this reasoning, output would remain depressed so long as the lockdown prevented production from taking place, but would spring back once these restrictions are removed. However, after they are lifted, we would return to a world in which output is determined by demand. This now introduces the possibility that output may not spring back, as investment may have actually declined post the lockdown. It would happen if depressed output causes private investors to hold their plans for the future and contract expenditure. A quarter is, after all, a very short period of time, and impulses in one may take effect only in the next.

Telling figures

The NSO’s press release makes speculation about investment behaviour unnecessary. We see in it that gross fixed capital formation at constant prices actually increased in Q2, indeed by a whopping 60%. It may be said that this was completely unanticipated, thus suggesting the prospect of growth in the future.

Three other sources of expenditure exist, namely, exports, private final consumption expenditure and government final consumption expenditure. The first two show a substantial increase over their Q1 levels, but the government final consumption expenditure actually declines by 25% over the same period. Could it be that the contraction in GDP would have been less but for this cut in government expenditure? From the NSO’s statement, we can determine the extent of contraction that would have occurred had the government maintained its consumption expenditure into the second quarter of this financial year. This figure turns out to be -4.1%, indicating that the contraction would have almost halved had this been the case.

As currently we do not possess the knowledge on how the gross fixed capital formation this year is divided between the public and private sectors, we are forced to confine our analysis to the government’s consumption expenditure alone. This reveals the stark reality that public consumption expenditure in the first half of the year of the pandemic has been less than what it was in 2019-20, a normal year.

The existence of a public sector provides us with an instrument to stabilise an economy subjected to a natural shock that depresses output. What we are experiencing in India today is actually the opposite, with the government having reduced expenditure in the face of a decline in output to a level lower than what it was two years ago. The macroeconomic consequences of the disruption to economic activity and the need for expansionary economic policy had been flagged by independent economists at the very onset of COVID-19. For fiscal policy in India to ignore that advisory and reduce spending when it is most needed is to destabilise the economy. It cannot be anyone’s case that an economy should be run on public consumption expenditure permanently. However, maintaining it for a little longer could have checked the economy’s slide with its negative consequences. It would have been the fiscally responsible thing to do.

Pulapre Balakrishnan teaches at Ashoka University, Sonipat, Haryana

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