Question

Arguments in favour of counter cyclical polic i ndia

Answer 1

Advanced countries have embraced fiscal activism, giving a greater role to counter-cyclical policies during crisis. But India’s experience has taught the opposite lessons increase spending  and deficit during accelerating growth lead to financial crisis during 1990’s and vulnerability during 2013.On primary deficit front India has been a outlier with high primary deficit vis-à-vis other countries. This means government is dependent on growth and favourable interest rates to contain debt to GDP ratio. Events have reaffirmed the need for rules to contain activism, so as to rein in excessive spending during booms and inordinate deficits during downturns.

Technical Terms

A. Procyclical and Counter Cyclical fiscal Policies – A ‘procyclical fiscal policy’ can be summarised simply as governments choosing to increase public spending and reduce taxes during an economic boom, but reduce spending and increase taxes during a recession. A ‘countercyclical’ fiscal policy refers to the opposite approach: reducing spending and raising taxes during a boom period, and increasing spending/cutting taxes during a recession.

B. Fiscal activism: fiscal policies of a government which believes in active participation in the national economy to affect its economic agenda and objectives.

C. Quantitative easing – One of the main tools they have to control growth is raising or lowering interest rates. Lower interest rates encourage people or companies to spend money, rather than save. But when interest rates are at almost zero, central banks need to adopt different tactics – such as pumping money directly into the financial system. Central Bank prints money and then uses this money to buy bonds from investors such as banks or pension funds. This increases the overall amount of useable funds in the financial system. Making more money available is supposed to encourage financial institutions to lend more to businesses and individuals. It can also push interest rates lower across the economy, even when the central bank’s own rates are just about as low as they can go. This in turn should allow businesses to invest and consumers to spend more, giving a knock-on boost to the economy.

Gist of Economic Survey Chapter

The Chapter compare Indian response on fiscal policies of flow (deficit) and stock (debt) compared to other world economies over the period and during time of crisis especially during global financial crisis and what should be India’s future fiscal policy framework toward these ends.

India and the World: Flows
As Advanced Economies (AEs) are taking path of activist fiscal policies considering challenges of weak economic activity and the inability to address this problem through monetary policy, India may have the need for counter-cyclic policy due to twine deficit problem and debt overhang.
However India’s situation differs from that of the AEs in some important ways which run counter to taking path of activist counter-cyclical policy. This include High growth rate along with substantially high inflation rate,As a result, monetary policy is nowhere close to the zero lower bound.
Apart from it India, India’s fiscal stance has an in-built bias toward higher deficits, because spending rises pro-cyclically during growth surges, while revenue and spending are deployed counter-cyclically during slowdowns. The inability to rein in these deficits played a key role in undermining India’s external situation which resulted in full blown crisis of 1991 and later crisis of 2013. This pattern creates fiscal fragility. Fiscal rules, insofar as they can be effective and binding, must therefore aim to prevent spending surge during booms and constrain counter-cyclicality during downturns.

India and the World: Stocks
India has stock problem which include high debt-to-GDP ratio compared to many other emerging markets. However its fiscal strength can be accessed by taking fiscal commitment and debt dynamics into consideration.
Regarding fiscal commitment,if fiscal and debt sustainability is about confidence and trust as revealed in the ability and willingness of governments to limit their debt levels and pay them off without disruption than India has a very good record of keeping its debt commitment both internally and externally.
On debt dynamics, the implications for the growth interest rate differential are stark. India would have a favourable growth interest rate differential compared to AEs because of its high growth rate for next 15 years. This is favourable for debt sustainability, however challenge lies in quite high primary deficit that is the shortfall between its receipts and its non-interest expenditures, compared to its peers. As a result of running a primary deficit, the government is dependent on growth and favourable interest rates to contain the debt ratio. This could result in upward spiral of debt ratio if growth rate and interest rates are faltered.

Answer 2

Explanation:

A 'countercyclical' fiscal policy takes the opposite approach: reducing spending and raising taxes during a boom period, and increasing spending and cutting taxes during a recession.