FE Editorial : Getting fiscal

Inflation continues to remain a serious concern for the government,even though the latest statistics revealed by the government show that the headline inflation rate...

Written by The Financial Express | Published:August 20, 2010 3:45 am

Inflation continues to remain a serious concern for the government,even though the latest statistics revealed by the government show that the headline inflation rate has now fallen marginally below 10%,into single digit territory. The chief statistician,TCA Anant,has suggested that fiscal tools may be more appropriate than monetary policy as a means to bring inflation down to more moderate levels. That is an interesting perspective from an establishment that has largely depended on monetary policy to tackle inflation these past few months. RBI has carried out four hikes in key policy rates since the middle of March. It has,of course,been our consistent view that monetary policy was not the appropriate tool to control an inflation that was being caused mostly by supply-side factors. This bout of inflation has clearly been led by a strong spurt in food prices,which were caused by a variety of supply-side bottlenecks in agricultural production,distribution and retail. And even if core sector inflation is now showing some rise,the Indian economy is still not ‘overheating’ in the traditional sense of that term—the IIP still continues to be sluggish and variable. And a sharp monetary tightening at this stage could hit growth.

How would using fiscal tools be different? After all,fiscal tools,like monetary tools,can be used to adjust the level of aggregate demand in the economy,not correct supply-side bottlenecks. But even if fiscal tools (expenditure cuts) are no substitute for the structural reforms the government needs to implement,they can be a useful short term instrument. There is a caveat pointed out by the chief statistician—the expenditure cuts must come in those sectors/areas that do not constitute productive spending by the government. This is often harder than cutting expenditure in productive areas,i.e.,public investment. This is because much of the non-productive spending fulfils certain populist aims of the government. In all fairness to UPA-2,it has taken some steps to rationalise petroleum and fertiliser subsidies. But more can be done to cut down wasteful expenditure by the government,including some rationalisation of food subsidies. Unfortunately,the UPA government hasn’t always shown much resolve to cut down on populism,choosing instead to try and bridge the fiscal deficit by mopping up more resources on the revenue side. But there are limits to that. A big deficit puts upward pressure not just on inflation but also on interest rates. That is a double whammy for growth,something the government must avoid.

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