Fiscal policy and inflation

Given that inflation, especially food inflation, has been an extremely sensitive issue, it was certain that the budget would assume a strong anti-inflationary stance. In his budget speech the Finance Minister admitted that the government could have done better in controlling food inflation The Reserve Bank of India, which has for long advocated a fiscal policy that complemented its monetary policy, would certainly take note of the anti-inflationary elements of the Union budget when it reviews the credit policy later this week. The most important of these is the large reduction in the fiscal deficit. As a proportion of the GDP, it is expected, according to the revised estimates for 2010-11, to come down to 5.1 per cent from the budgeted figure of 5.5 per cent. For 2011-12, the budget aims at an even more ambitious target of 4.6 per cent. On paper, the government's commitment to fiscal consolidation is not in doubt. However, the windfall from the sale of 3G and broad band spectrum which has brought down the deficit sharply this year will not be repeated in the near future. At a more general level, the assumptions of tight expenditure management and revenue buoyancy to bring about fiscal consolidation will be closely watched.

Total government expenditure for 2011-12 is budgeted to be only three per cent more than this year, with a sharp contraction in non-Plan spending and a very modest rise in Plan outlay. It is doubtful whether any government can realistically cut down expenditure to such an extent. Moreover, the outlays for subsidies seem meagre. The budgeted expenditure on the government's key social sector programmes might well fall short of the money required. On the revenue side, the government is banking on robust economic growth and the consequent higher tax revenues. Even so, the anticipated increases in corporate tax collections (21.5 per cent) and excise collections (19 per cent) appear to be on the high side. The upshot of all this is that the government may be hard pressed to stick to its planned fiscal consolidation. Consequently, it might be forced to borrow more than what is budgeted for or raise taxes in a supplementary budget. What all these would do to inflation and inflationary expectations is anybody's guess. There are many who question the connection between deficit reduction and inflation control. For most part of the current year, the rise in inflation was attributed to demand-supply imbalances due to a poor monsoon and spike in the prices of specific food items. Deficit reduction, as a single line of attack, will meet with only limited success under these circumstances.