Tight fiscal policy no cure for India (page 1 of 2)

Multilateral lenders, foreign analysts and investors universally believe that fiscal consolidation should be the centerpiece of economic policy changes implemented by India's new government headed by Prime Minister Manmohan Singh.

The call for fiscal consolidation is supported by the mistaken conviction that reduction of the fiscal deficit will accelerate long-term economic growth in India. As proven in Latin America over the past 15 years, fiscal consolidation in India will lead to slower economic growth and political and social instability.

If the Singh government hopes to quicken the pace of economic growth it must increase public sector investment and government subsidies. India should use, to the fullest advantage, the economic policy latitude it enjoys as a result of the very limited leverage multilateral lenders hold over the country.

The electoral drubbing dealt on the NDA government by the India National Congress (INC) and India's leftist political parties shocked both government cadres and outside observers. After all, India was enjoying the fruits of strong economic growth and booming asset markets. That the incumbent should lose the elections under such positive circumstances was almost unthinkable.

However, the electoral demise of the Vajpayee government was obvious to anyone acquainted with India's increasingly unstable social environment - a product of rising unemployment, declining wages and deteriorating social conditions. India was not shining for millions of voters. These voters used their ballots to register their opposition to economic reforms first implemented in the early 1990's and modestly accelerated by the Vajpayee government.

These reforms, which included reduction of public sector investment and government subsidies, trade liberalization and accelerated privatization of public sector companies, benefited only a small proportion of India's population as well as foreign investors. For the bulk of the population these reforms were deleterious.

India's electorate has given the INC-led government, along with its leftist allies, a strong mandate for a revision of economic policy. Inherent to the electorate's expectations are greater government focus on social development through increased public sector investment and government subsidies.

In sharp contrast to the electorate, multilateral lenders, foreign analysts and investors expect changes in economic policy to include tighter fiscal policy implicit to which is further reduction of public sector investment, expenditure on subsidies and the continued decline of social development.

In the face of irrefutable evidence to the contrary, these lenders, analysts and investors glibly believe that tight fiscal policy will lead to accelerated economic growth in India. Argentina and Brazil, which have long followed IMF-directed fiscal adjustment policies, provide excellent examples of the negative impact tight fiscal policy has on economic growth and social and political stability.

Over the past 15 years the IMF has conditioned credit for Argentina and Brazil on the maintenance of tight fiscal policy. The IMF assumed that tight fiscal policy would lead to steady decline of the debt burden in these countries, thus supporting accelerated economic growth and underpinning foreign and domestic investor confidence.

However, the outcome has been much different. Tight fiscal policy in both Argentina and Brazil undermined economic growth, leading to rapidly increasing debt burdens in both countries.