Thursday, January 5, 2012

Fiscal and Monetary Policy-The Road ahead for India

Amid fears of a global economic meltdown, the country’s fiscal and monetary policy shall play a key role in defining the roadmap for the country’s development. So far, the Reserve Bank of India has followed a tough monetary stance, increasing key policy rates continuously with an objective of controlling the spiraling inflation. This has had a negative impact on the growth which has resulted in many economists considering the possibility of a GDP growth below 7% for the year. Lower tax collections (due to slowdown of economic activity), high levels of expenditure on subsidy and lower proceeds from disinvestment may cause fiscal deficit to exceed the ambitious 4.7% (of GDP) target this year.

As inflation has begun to cool down (albeit due to base effect) and corporate earnings data show revenues hit by higher financing costs due to higher interest rates, it is expected that the RBI will lower key policy rates to stimulate demand in the economy and address supply side inflation oriented constraints. This is expected to end the continuous policy hike seen during the last 19 months, and bring back investor confidence, enhance credit delivery, stimulate economic activity and thus strengthen the consumption story India possesses. As Indian companies face problems in raising external commercial borrowings due to global economic slowdown and euro sovereign debt crisis, it is expected that this move will come as a breather for them and would enhance their earnings.

With regard to fiscal policy, implementation of Direct Tax Code along with higher corporate earnings is expected to enhance government tax revenues. However, it is expected that government expenditure will stay high, partly due to the need of investment in infrastructure following the 12th five year plan and partly due to the assembly elections to be held in 2012. Thus fiscal deficit is expected to be in a 5-7% range over the next few years.

Narottam Garg|Guest editor

2 comments:

  1. I still admire India's ability to handle it's finances despite the economic slowdown. It will better if they will be able to address their high poverty rate despite their improving economy.

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  2. I think stabilisation policies can be implemented with the aid of either monetary or fiscal policy. Fiscal policy can promote macroeconomic stability by sustaining aggregate demand and private sector incomes during an economic downturn and by moderating economic activity during periods of strong growth.

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