Mukherjee at Minsky moment - a clarification

A few friends of mine showed caustic reaction through phone calls to my previous blog by blaming me for not understanding the importance of reducing fiscal deficit. One of them was a professional economist working in a small south Indian university.

Let me clarify my position. In normal period, when foreign banks are not closing at a fast rate affecting jobs all around the world, I am totally in for reducing the fiscal deficit and if required even build up a fiscal surplus. But during the current crisis, I would advise not to go for fiscal retrenchment. The problem in India is not the fiscal deficit as such, but its distribution and how it is funded. Here is the take of Roubini's Global Economonitor on India's situation:

However, the annual growth rate for Community, Social and personal services has remarkably increased to 13.1% in 2008-09 as compared to 6.8% in 2007-08 reflecting the impact of increased expenditures by the Government through financing schemes like NREGS. It is important to notice that such expenditures have not only increased the fiscal deficit beyond the estimated budget for 2009-10, but only 9% of the Indian workforce engaged in Community, Social, and Personal services expected to be benefited through it. Thus the excess flow of subsidized bank credits to GoI for financing the budget deficit is ultimately restraining the economic growth.

Herbert Hoover tried fiscal retrenchment during a downturn that was one of the prime reasons for the Great Depression. FDR's fiscal retrenchment was the reason for a double-dip depression. During both these times, many economists and Wall Street welcomed the move. But in hindsight, it turned out to be an incorrigibly bad choice. Here is the President's chief economic advisor talking about the lessons from the Great Depression. I am just happy that India is not repeating that mistake.

Mukherjee at Minsky Moment

In India, Mr. Pranab Mukherjee presented his first budget of this term on July 6th. The budget speech was criticized heavily by economic luminaries. Sensex responded by falling down by 870 points. Pranab Mukherjee has gone into a spending spree on infrastructure and building social security safety net. Dr. Jayaprakash Narayan called it a lackluster budget with fiscal deficit crossing Rs. 10 lakh crores. While I agree with Dr. Narayan’s point on reduced allocation to healthcare, I beg to disagree with his view on country’s deficit control.

I accept that India is in the middle of a huge debt. But let us not blame Mr. Mukherjee for this. We have been running huge fiscal deficit for the past several years. Currently we are in the middle of a great recession. This is not the right time for deficit control. Mukherjee did the right job, a Keynesian economist’s job, by increasing the fiscal spending to control the impact of the downturn. While fiscal deficit is something that we have to control in long run. At the middle of Minsky moment, Pranab Mukherjee has done a decent job by not minding it this time.

However once the recession is over, the finance minister (whoever will be, at that time) must ensure to reduce the fiscal deficit in the same Keynesian style with which they increased fiscal spending this year. Don’t care about the reaction of Sensex; don’t care about Narayan’s comment. You have done a good job at the bad time, Mr. Mukherjee! Fiscal deficit control? Previous finance ministers should have done it. Future finance minister should do it. Not this finance minister.