Raghuram Rajan warns against using fiscal deficit to stimulate growth

The RBI Governor revealed his stand on the ongoing debate whether the government should use extra borrowing to produce economic stimulus. At the CD Deshmukh Memorial lecture, Raghuram Rajan expressed that such a policy will produce macroeconomic instability in the economy.

Recently, Finance Minister has convened a meeting of economists asking their opinion on the feasibility of a higher fiscal deficit in the next budget.  The meeting was undivided in their opinion with a group supporting the view that a deviation from FRBM targets is not bad if the government is making additional infrastructure expenditure.

Opposing the higher fiscal deficit view, the RBI Governor cited the dismal scenario of the Brazilian economy. “As Brazil’s experience suggest, the enormous costs of becoming an unstable country far outweigh any small growth benefits that can be obtained through aggressive policies. We should be very careful about jeopardizing our single most important strength during this period of global turmoil – macroeconomic stability”

The estimated fiscal deficit for the last budget was 3.9% which the government may realize this fiscal. Target for the next fiscal is lower as the government is in a road map to reduce it to 3% of GDP.

At the same time, a group of economists are of the opinion that extra funding in core areas like infrastructure is beneficial especially if the economy is to achieve higher growth rate.

RBI’s stand is that higher fiscal deficit will bring more inflation and it may distort economic activities in general.

The RBI is in an uncomfortable zone in recent months as inflation is making a notable come back. Monthly retail inflation has reached 5.61% in December compared to the RBI’s comfort zone of 4-5%.