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Day 14 – Q 2. What do you understand by fiscal targeting? What is its significance for the economy in general? Illustrate. 

  • IASbaba
  • June 25, 2020
  • 0
GS 3, Indian Economy, TLP-UPSC Mains Answer Writing
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2. What do you understand by fiscal targeting? What is its significance for the economy in general? Illustrate.  

राजकोषीय लक्ष्यीकरण से आप क्या समझते हैं? अर्थव्यवस्था के लिए इसका क्या महत्व है? उदाहरण देकर स्पष्ट करें।

Demand of the question:

It expects students to write about the concept of Fiscal targeting and its significance for the economy in general.

Introduction:

Fiscal targeting assumes more importance as many countries adopted stimulus measures to deal with economic slowdown. However, excess liquidity may carry a high social cost. Beyond the usual fears about debt and inflation, there is also good reason to worry that the excess cash in banks will be funnelled toward financial speculation, leading to still more precautionary behaviour, and discouraging both consumption and the investment needed to drive the recovery.

Body:

Fiscal targeting: 

  • Fiscal deficit targeting is also known as fiscal targeting to achieve objective of fiscal consolidation. India follows obligation under FRBM act to limit its fiscal deficit in prescriptive manner and adopt various strategies to deal with fiscal deficit. 
  • The FRBM Act, aimed at establishing financial discipline, provides for a trigger mechanism for a deviation from the estimated fiscal deficit on account of structural reforms in the economy with unanticipated fiscal implications.
  • Fiscal targeting resolves around judicious and balanced call keeping in mind the need to support the economy on one hand and the sustainable level of fiscal deficit that is consistent with macroeconomic and financial stability on the other.
  • Centre’s fiscal deficit in 2020-21, as things stand now, could be 1.7-1.8 percentage points higher than the 3.5% of GDP, which was targeted in the Budget, said Chief Economic Advisor Krishnamurthy Subramanian in June. Assumption of Fiscal deficit to be 5.2 -5.3% of GDP is based on 10% nominal GDP growth, which would have been tough without COVID-19 outbreak.

However, the Indian economy seems caught between tight fiscal targets prescribed under the FRBM (Fiscal Responsibility and Budget Management) review and a government which treats them as cast in stone, even at a time when the economy is reeling under the impact of the COVID-19 crisis.

Significance of fiscal targeting for economy:

  • In the absence of fiscal targeting, higher fiscal deficit for an economy means increased government borrowing, which in turn implies higher interest burden. India has a debt-to-GDP ratio of 70%, which is the highest among its emerging market peers. 
  • Even though, Most of India’s government debt is internal (from domestic market), implying less external vulnerability. Nevertheless, high government debt implies high interest burden and the threat of economic instability.
  • Many of the developed economies like the US and Japan have much higher debt-to-GDP ratio. However, their interest burden is much less as their governments are borrowing at much lower interest rates. 
  • The other disadvantage of a high debt-to-GDP ratio is that it has an impact on the country’s credit ratings and investor sentiments.
  • Higher government borrowing crowds out private investment in the economy. 
  • While there is no doubt that the government should be fiscally prudent, what is being increasingly debated is whether our fiscal management should be counter-cyclical. This means that when economic growth is above potential, policymakers should reduce fiscal deficit. Similarly, when economic growth is poor, fiscal deficit should be allowed to expand (within a ceiling) in order to support economic growth.
  • While it is ideal to have a rule-based fiscal consolidation path, experience shows that there are threats of genuine disruptions. Like present COVID-19 pandemic recession following a fiscal deficit target under present circumstance could result in adverse impact on developmental expenditure.
  • However there is need to be more prudent in not allowing unproductive expenditure on populist measure. 

Conclusion:

In the present COVID-19 pandemic induced slowdown, governments have to consider paradox of thrift and spend more. However, all measures should be well targeted to optimise the outcome. There is need to maintain balance between expansionary austerity and fiscal slippage. 

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