Fiscal consolidation and economic growth in India: Do policymakers need to shift focus from quantity to quality of fiscal adjustments?

• Published date: 01 August 2020
• Author: Naseer Ahmad Khan,Ishfaq Ahmad Khoja
• DOI: http://doi.org/10.1002/pa.2060
• Date: 01 August 2020

ACADEMIC PAPER

Fiscal consolidation and economic growth in India:

Do policymakers need to shift focus from quantity

to quality of fiscal adjustments?

Ishfaq Ahmad Khoja

1

| Naseer Ahmad Khan

2

1

Research Scholar School of Economics,

University of Hyderabad, Hyderabad, India

2

Faculty School of Economics Central,

University of Hyderabad, Hyderabad, India

Correspondence

Ishfaq Ahmad Khoja, Senior Research Scholar

School of Economics, University of Hyderabad,

Telangana Hyderabad India, 500046.

Email: ishfaqmajeed.ku@gmail.com

This paper evaluates the impacts of fiscal consolidation programmes and their com-

position on the growth rate of national income for Indian economy. More specifically

the study tries to address two questions that is, composition of consolidation and its

resultant impact on growth rate of income and the relative desirability of alternative

sources of deficit financing that is, internal versus external borrowing. The study

employed time series data from 1990–1991 to 2017–2018 and used the technique

of ordinary least square and generalized method of moments. The study finds that, in

long run, fiscal consolidation need not be necessarily recessionary in nature. More-

over, the composition of consolidation was found to have a significant impact. The

study could not extend empirical support in favour of back-loaded (spending

financed) consolidation design as has been established for advanced economies.

Moreover the study could not establish the negative impacts of revenue funded

(both tax and non-tax) fiscal consolidation on the growth rate of economy. The study

documented that it is desirable to target expenditures such as subsidies, transfers

and interest payments to infuse more discipline. A judicious mixture of both spending

cuts and revenue increase may be a better strategy to consolidate in order to have

better returns. The study highlighted that the external source of deficit financing is

always costlier against the internal borrowings. The study noted that it is imperative

on part of policymakers to shift their focus from quantity to the quality of deficits

and the resultant consolidation programmes.

1|INTRODUCTION

A healthy fiscal scenario over the long run is good for growth has been

established both empirically as well as theoretically (Easterly, Loayza, &

Montiel, 1997). However, the effects of fiscal consolidation on

growth, its success or failure besides composition and many more are

the areas of debate. The literature on fiscal policy is yet to arrive at

some unanimity regarding the impact of consolidation policies on mac-

roeconomic indicators, at least in short run (Cogan, Taylor, Wieland, &

Wolters, 2013; Gupta, Clements, Baldacci, & Mulas-Granados, 2005;

Pashourtidou, Savva, & Syrichas, 2014). The recent research has taken

the debate to deeper levels by analysing the aspects such as composi-

tion, quality, size and source of consolidation programme and their

resultant impact on the economic growth. In this context, the compo-

sition and quality stands for the relative contribution of different bud-

getary items to the adjustment effort (Von Hagen & Struch, 2001).

The good quality consolidations are defined as adjustments financed

by expenditure cuts rather than tempering with the tax revenue

sources.

1

However such policies may invite political repercussions

given the political sensitive nature of these expenditures such as sub-

sidies and transfers (Perotti, 1999). Size, source and persistence of

consolidation programme are yet other emerging areas and have been

receiving special attention post-financial crises (Erceg & Lindé, 2013).

The key insights emerging from the research in last two and a half

decades attach primary importance to the qualityof composition as the

main determinant of success and/or failure of consolidation strategies

Received: 8 October 2019 Revised: 5 November 2019 Accepted: 20 November 2019

DOI: 10.1002/pa.2060

J Public Affairs. 2020;20:e2060. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons, Ltd 1of10

https://doi.org/10.1002/pa.2060