Pursuit of fiscal prudence leads to stagflation

It appears that the fiscal policy managers were banking on monetary policy to bail the economy out.

The inflation numbers for May, CPI has crossed the RBI threshold of 6 per cent and WPI is at an all time high, have under lined the precarious nature of the ongoing economic recovery. As the second wave comes to an end and the restrictions are eased, the economic activity has been picking up. The Nomura India Business Resumption Index (NIBRI) jumped to 76 in the week ending with June 13. The consumer confidence continues to remain low. High inflation at the moment will put a squeeze on the household budgets.

A spike in the prices of essentials hurts even in the normal circumstances but these are far from the normal times. The labour market conditions have been weak, the employment and wage earning have not yet recovered. The large amount spent on health during the second wave has destroyed the household balance balance sheets for the millions of households.

The fiscal policy response ever since the pandemic hit has been largely pro-cyclical. The Ministry of Finance gave provisional numbers that showed the gross tax revenue went up in 2020-2021 despite the GDP contraction. The sharp increase in taxes on petrol-diesel made the increase in Gross Tax Revenue.

The Government has however justified the continuation of higher duties on the ground that it is essential for the revenue mobilisation. But the government needs to realise that it has led to crowding out private spending.

It appears that the fiscal policy managers were banking on monetary policy to bail the economy out. The loan guarantee and cheap credit were instrumental in preventing destruction of productive capital, although it can not generate demand when the consumers sentiment are low and companies were saddled with an excess capacity.

As the inflation rises, the RBI will be forced to withdraw the monetary stimulus. The pursuit of fiscal prudence at the moment would only lead to low growth and high inflation.

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