The 2012-13 Economic Slowdown and Budget Deficit

Introduction

The budget is a statement presented by the government of a country with statement of estimated expenditure and revenues for the following financial year, actual receipts and expenditure of previous year and proposal of ways and means to raise the receipts and meet the expenditure for the following financial year. It is the reflection of the position of government in previous financial year. The union budget for any given year gives the idea of the revenue and expenditure of the country by using data of its capital account and revenue account. The budget is said to be in deficit when expenditure is greater than the revenue, neutral when expenditure is equal to the revenue and surplus when the expenditure is less than the revenue. In an ideal world where the government works at its full capability, budget deficit would be the most viable option for developing countries as their main focus is on generating additional demand, the development of infrastructure and improve employment rate. The excessive expenditure by the government will help in achieving great returns in future which in turn will revive the economy of the country.

Case Study: The economic slowdown and budget deficit of 2012-2013

The world faced a recession in 2008 which started with financial crisis in U.S. India was also affected due to the recession and was curbing to come to come out for recession. Government along with RBI brought in different policy and measures to increase the growth rate. During the recovery of the economy, India faced economic slowdown during 2012-2013. The major economic problems were inflation, fiscal deficit, fall in investment levels and widening of current account deficit. The economy grew at its slowest in this period with a growth rate of 4.5% which was estimated to be 5%. “There was a sharp cut in GDP forecast of 5.2% to 3.7% for fiscal year 2014 estimated by BNP Paribas, France biggest listed bank”.

Consequences of the Economic Slowdown

The budget deficit was mainly caused due to fiscal deficit that widened to 5.7% of GDP in 2011-12 and current account deficit that swelled to 4.8% of GDP during 2012-2012 from 4.2% of GDP in 2011-12. Fiscal deficit in a budget is total expenditure minus total revenue but the total revenue here excludes the loans and borrowings of the government that has repayment liabilities i.e if the fiscal deficit is estimated, it helps us in determining the loans and borrowings government has taken to compensate for the excessive expenditure. Since the economy of all the countries were recovering at that period due to the global recession of 2008, the decline in investment along with the huge budget deficit was mainly caused due to increasing oil prices, lower exports and higher imports of metals like gold and coal. A high fiscal deficit was a cause of concern for the Indian economy as due to it, inflation increased, rate of interest increased, monetary policy expansion became constrained, external sector imbalances widened and investment growth and employment took a hit.

To curb the problem of large budget deficit, the government adopted expansionary fiscal policy. Expansionary fiscal policy deals with either increase in government spending or cut in taxes. The government took the initiative by cutting the income tax which increased the disposable income of the consumers enabling them increase their spending. The idea was to increase the consumption which is directly related to increase in aggregate demand with the aim of higher economic growth. The government also increase their spending to bring injection in the economy that would stimulate the economic growth and activity. Fiscal policy was preferred over monetary policy action because the economy was already in steady state and the scope of increasing money supply or relying on changes brought by central bank that would indirectly encourage investment was not seen as a viable option. Alternatively, the increased government spending would increase investment in public work schemes, creating jobs which will increase income leading to greater aggregate demand.

Limitations of Expansionary Fiscal Policy

It was observed that that due to increase in aggregate demand, the rate of inflation also increased. The government spent a lot on subsidies and unemployment benefits due to decrease in their real income. This increase in government spending was seen sceptical to control leading to widening of the deficit gap more. Along with these issues, to cover up the extra spending, government sold their bonds to public and borrowed which led to crowding out effect that is the investment in private sector decreased and the investment in government sector increased. The interest rate also increased with the increase in government spending which further discourage investment. The interest rate on return of bonds sold by the government also increased, increasing the burden on the budget. As financial sector was in a bit of turmoil due to massive non-performing assets, it only led to increase in interest rates declining the growth of the economy. A lot of policy initiatives were taken but overlapping of economies along with the limitations of expansionary fiscal policy with the mismanagement between the fiscal and monetary policy lead to derailing of the economy.

Analysis of Expansionary fiscal policy with IS-LM framework

The IS-LM framework put forward by Keynes analyses the importance of expansionary and contractionary fiscal and monetary policy in increasing the output and growth of the economy. It also gives an overview of the policy effectiveness of IS-LM framework. Different school of thoughts have different opinions on the influence of budget deficit on the economic growth.

The framework explains the effectiveness of expansionary fiscal policy. It claims that if there is increase in government spending or decrease in tax rates, there will be an increase in income lesser to what it had been due to crowding out effects which will increase the rate of interest.

 It also states that for positive effect of expansionary fiscal policy on the economic growth, it should be accompanied by contractionary monetary policy to retain the level of output and control inflation. This leads to rightward shift (expansion) of IS curve and leftward shift (contraction) of LM with output at same level but further increase of the interest rate that makes this policy more anti-growth policy.

Conclusion

The Indian economy has always been a challenge because of the demographic factors, population, and effectiveness of policies in present times. The economic slowdown decreased the growth of economy for 2011-2014 and took almost five years to bring a stable growth rate in the economy. The budget of India has always been deficit in nature due to the massive past loans and borrowings, government took when the country became newly independent as India was not self-sufficient as they had just emerged from the British dominion. Keynesians approach of IS-LM tries to provide a way to decrease these deficits but the Indian economy is a lot more complex than the economic situation given in the framework making it difficult for India to overcome its budget deficit. Not only this, as our country is still developing, we need to borrow to develop our infrastructure to increase demand and generate employment. Many different combinations are being used by the economists to combat the problem of budget deficit and with the guidance of the government in correct way, India will be able to decrease the gap of their budget deficit in near future.

Reference

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India's Economic Problems: Difficult Road Ahead?

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