Day 29 – Q 5. Comment upon the status of India’s twin deficits. How do they affect India’s monetary policy?
5. Comment upon the status of India’s twin deficits. How do they affect India’s monetary policy?
भारत की जुड़वां घाटे की स्थिति पर टिप्पणी करें। वे भारत की मौद्रिक नीति को कैसे प्रभावित करते हैं?
Twin deficit economy is one that has both fiscal and current account deficits.
Fiscal deficit means government expenditure is more than its revenues. While Current Account Deficit (CAD) means imports are higher than exports and hence foreign funds are needed to manage the deficit. These two deficits are expressed as a percentage of GDP.
Status of Twin Deficit
- Finance Minister while announcing the Budget on February 1, had set the target for fiscal deficit at 3.3 per cent for the current fiscal. India’s fiscal deficit touched 94.7% of the budgeted target during the April-August period
- India’s current account deficit widened sharply to USD 19.1 billion, or 2.9 percent of GDP, in July-September 2018-19 from USD 6.9 billion, or 1.1 percent of GDP, in the same period of the previous fiscal year.
Reasons for high Fiscal deficits and CAD
- Higher oil prices add to short-term fiscal pressures, the reduction in the goods and services tax on some items and relatively high increase in the minimum support prices for some crops. According to Moody’s analysis
- Higher oil prices will also contribute to a wider current account deficit
Impact of fiscal deficit
- High fiscal deficit means government is not able to earn as much as it is spending. So often it raises taxes in some form or the other. The government, in order to repay its debt, is likely to levy more taxes in the future. It could be either higher inflation or higher taxes. Or, worse, it could be both.
- Higher government expenditure will push up demand and generate more money in the economy. This may lead to higher inflation.
- In an emerging economy like India, a higher fiscal deficit leaves little room for interest rate cuts. A higher interest rate may affect private investments from taking off in a growing economy like India. Banks have already witnessed a slowdown in credit take-off. Borrowing costs may remain high for consumers (vehicle and house purchases or personal loans) and industry/companies
- More than average borrowing by the government from the market leaves that much less pool for private sector to borrow, stalling its growth plans.
Impact of high CAD
- Higher CAD will put the rupee under pressure and may raise the cost of overseas borrowing. Depleting forex reserves could raise CAD further.
Effect of Fiscal deficit and CAD on Monetary policy and solutions:
1)To control inflation: Monetary Policy committee has been given mandate to maintain inflation.
2) The government has announced five measures to rein in CAD. These include: a review of the mandatory currency hedging requirement for infrastructure loans, permitting manufacturing sector entities to avail of external commercial borrowings up to $50 million with a minimum maturity of one year, a review of the debt investment limits for Foreign portfolio investors, exempting the withholding tax for masala bonds and removal of restrictions on Indian banks’ market making of masala bonds.
3)Not just curb imports but also to increase exports.
Twin deficit problem can be solved if India sets out a well-planned roadmap to meet targets. It is better to get as close as possible to a difficult target than merely lowering the target.
Best Answer: Aniket Sachan