Why Modi government is moving away from the path of economic austerity

The Narendra Modi government, which kept a hawk-eye on spending over the past seven years, has said that the fiscal deficit for 2020-’21 will stand at 9.5%. This would be the highest at least since India liberalised its economy in 1991.

For context, the fiscal deficit for 2019-’20 was 4.6% of India’s gross domestic product.

On the face of it, a high fiscal deficit – the difference between the government’s revenues and expenditure – is alarming. It increases government borrowings and sends it into an interest repayment cycle, which only further increases spending in the future.

Governments in the past have taken the route of austerity to keep the fiscal deficit in check. This has been a common economic strategy, its biggest champions being former US president Ronald Reagan and former United Kingdom Prime Minister Margaret Thatcher in the 1980s.

Austerity is a measure where governments cut down on spending to close the fiscal gap. Given the extenuating circumstances of the Covid-19 pandemic and its devastating blow to India’s economy, experts feared the ballooning fiscal deficit would drive the government towards the path of austerity.

But the Budget announcements towards capital expenditure and not setting a steeply low fiscal deficit target for the coming financial year are a breather for economists worried about austerity measures.

The fear against austerity comes from the global examples of its failure to bring economies out of deep distress.

Austerity: A failed economic model

Thatcher was one of the strongest advocates of cutting government spending. In 1979, she cut the UK government’s spending by 10%, creating a policy that projected the fiscal deficit coming down from 7%-8% of the GDP in 1980-’81 to 4%-8% by 1984.

Austerity was a popular conservative economic outlook, also widely supported and used as a measure by the International Monetary Fund for monitoring economies. It formalised this outlook through the Maastricht Treaty of 1992, which stated that countries in the European Union must not have a fiscal deficit exceeding 3%, and government borrowing exceeding 60% of the GDP.

The 3% fiscal deficit target is also codified in India’s Fiscal Responsibility and Budget Management Act of 2003, which the Indian government now hopes to return to after 2026.

But as with Thatcherism and the years of recession in the UK that followed, austerity has been widely proven to be unsuccessful in helping struggling economies get back on their feet. During the bailout for Greece’s economy in 2008, austerity measures proved catastrophic for the country’s inequality, and its ability to come out of its debt burden. This was a story that played out during Italy’s economic crisis of 2010, too.

The IMF, too, has reversed its hard stance on debt-to-borrowing ratios and a country’s fiscal deficit while advancing loans in 2016. But it has often been criticised for adding clauses of austerity for loans to lower-income countries. For instance, the Ecuadorian government had to announce an austerity package for a loan backed by the IMF in 2019. It later withdrew this package after facing huge civil unrest.

These failures of austerity measures are primarily the reason that US president Joe Biden and the US treasury secretary Janet Yellen have pushed for a large government stimulus package to the tune of $1.9 trillion. Yellen, in January, defended this move to the US Senate. While acknowledging the country’s mounting debt burden, she said, “…Right now, with interest rates at historic lows, the smartest thing we can do is act big. In the long run, I believe the benefits will far outweigh the costs, especially if we care about helping people who have been struggling for a very long time”, according to The Washington Post.

This also appears to be the thrust behind Indian finance minister Nirmala Sitharaman’s stance on increased government spending.

Will India stay off the path of austerity?

India’s borrowing has shot up to nearly 84% of the GDP according to estimates in the current 2021 Budget. It has also set a fiscal deficit target of 6.8% for 2021-’22.

If it were to keep its spending up, the government would need to borrow more and increase tax revenue. Divestment is also an important projected revenue source, and the Modi government hopes to raise Rs 1.75 lakh crore by March 2022. But if the government has to stick to its spending estimates, economists say it must also look to collecting more tax.

Such tax collection would only be possible through a boost to job creation, which economists fear the government does not address. “There was no clear statement in the Budget on boosting employment, especially female employment, which has been falling over the last several years,” Ashwini Deshpande, professor of economics and the founding director of the Centre for Economic Data and Analysis at Ashoka University, wrote in The Indian Express. “Infrastructure spending (which, not unsurprisingly, was targeted towards poll-bound states) might boost employment to a certain extent, but it is not clear that the increased outlay is sufficient to meet the massive employment challenge.”

Curiously, the Indian government did announce some austerity measures in June 2020, choosing to withhold spending for welfare schemes other than those under the Atma Nirbhar Bharat package for Covid-19 relief announced in March. In the past too, the government under prime minister Narendra Modi has cut spending for fiscal consolidation. It cut non-planned public spending by 10% in 2014, for instance.

The Covid-19 economic package, too, was criticised for focusing on offering more liquidity to businesses and people rather than offering a real stimulus. In fact, between April and September 2020, government spending was lower than the same period a year ago, Mahesh Vyas, MD and CEO of think tank Centre for Monitoring India, wrote in The Economic Times newspaper.

The true nature and extent of government spending and its stimulus for the economy will only be clear once the economic survey comes out in January 2022. And only then will the Modi government’s attitude to austerity truly emerge.

This article first appeared on Quartz.