Competitive Exams: Current Affairs 2011: The twin deficits

The twin deficits

The fiscal deficit is likely to overshoot the budgeted provisions. If the economy slows down further as is anticipated, the erosion in revenue will magnify the fiscal slippage. Also, the space for counter cyclical fiscal policies is more limited than it was at the time of the global crisis in 2008.

On a more positive side, the current account deficit (CAD) is expected to be contained within a sustainable 2.7 − 3 per cent of GDP. The export performance has been robust in 2010 − 11.

However, by all accounts exports are expected to slowdown later this year due to the deceleration in the advanced economies. Software exports too will be affected as bulk of them are to the US and Europe.

Capital flows are more difficult to anticipate. Their ebb and flow depend on the degree of risk aversion. If the global crisis deepens, capital flows will moderate. However, capital flows can increase in spells on a relative return basis and due to interest differentials.

Medium term challenges

The immediate challenge to sustaining high growth lies in bringing down inflation. Over the medium term, however, growth can be sustained only by addressing the structural bottlenecks.

The medium term challenges are: Lowering inflation and inflation outlook to acceptable levels; harnessing technology for agriculture productivity enhancements; maintaining right balance between consumption and investment; facilitating energy security; facilitating infrastructure finance; and promoting financial inclusion and inclusive growth.

IMF's dire warning

The International Monetary Fund has a creditable record of spotting, and tracking, world economic recovery more accurately than most other global institutions. As such its prognosis has always been keenly watched. Hence its warning, first issued while launching the latest edition of the World Economic Outlook on Tuesday and repeated on at least three different occasions, that the global economy was in the danger zone ought not to be treated as a hyperbole.

The onus of taking corrective measures is squarely on politicians round the globe, and not just on those in the United States who have displayed an amazing disharmony in sorting out key economic issues.

As Indian experience too demonstrates, a fiscal policy that is dictated by political considerations cannot complement the monetary policy adequately to achieve key objectives, such as reining in inflation.

The global growth forecast for 2011 has been marked down to 4 per cent from 4.3 per cent. That small decrease in percentage terms, however, does not fully reflect the fears and forebodings of the IMF, which stand reinforced by its Global Financial Stability Report (GFSR), released almost simultaneously with the WEO. The report serves as an early warning system and recommends policy action to stave off a crisis.

There are ample reasons for policymakers of both the developed and the developing countries to worry, as risks of financial instability have increased significantly in the past few months.

The global financial crisis that began with the US sub prime loans and then morphed into a systemic banking problem with international implications is far from being resolved. The sovereign debt crisis in the euro zone countries represented the next stage. Now, there is a political phase where a consensus on fiscal consolidation and adjustment has been eluding the politicians on both sides of the Atlantic.

As part of a three

pronged action plan for the developed countries, the IMF has called for a credible, medium term fiscal adjustment plan. The US should take steps to resolve the problem of overstretched household balance sheets through an aggressive restructuring programme. Thirdly, the banking sector in Europe should be fixed immediately, if necessary through infusion of capital.

Developing countries need to avoid a further build up of financial imbalances. In words that seem prophetic, the IMF has cautioned that countries such as India will face a sudden reversal of capital flows if foreign investors see their growth prospects petering out. In the post crisis period, country risk assessments have become more important than interest differentials.

Courtesy: The Hindu and Times of India