Why should you worry about rising Fiscal Deficit and Depreciating Rupee?
Every day we get to read about slowing growth, depreciating rupee and rising fiscal deficit. Does it really matter for a common man who is working hard to fulfill his daily needs? Here are few reasons why Indian middle class should care about these macroeconomic factors.
Fiscal Deficit is difference between government’s total expenditure and revenues. Revenues earned by government are received from sources such as taxes, profits earned by government owned corporations and voluntary donations. In first quarter of current fiscal year, India’s deficit stood at 2.63 trillion rupees ($43.57 billion). To finance difference between earning and spending, Govt. borrows money from public by issuing bonds. This decreases the amount of money flowing in the economy and consequently increases borrowing cost for others. With higher borrowing cost, businesses will be reluctant to take loans and invest in new projects, which will directly affect country’s growth and employment rate. Finance Minister Mr. P. Chidambaram has said government will not let deficit to rise above its target of 4.8% of GDP. With ambitious “Food Security Bill”, govt. will have to increase subsidy on food grains adding to its expenditure. Now to maintain deficit, either it will increase taxes or cut down subsidy on other items like petrol and diesel. Both will result decrease in purchasing power of common man. Reduction in subsidies will cause prices to go up (inflation) and increasing taxes will leave less money that people can spend.
Our government is struggling to maintain deficit level and at the same time U.S economy is recovering which has raised concerns about Fed’s tapering of stimulus program. This means the era of easy money will end soon. It has already caused total of over $10 billion outflow from Indian Markets causing depreciation in Rupee. Rising fiscal deficit makes securities denominated in rupee less attractive for foreign investors, which further adds pressure on our currency. Indian economy is highly reliable on imports. Depreciating currency makes imports more expensive, pushing cost of manufacturing upwards. This cost is directly reflected in selling price of manufactured goods causing higher inflation. Some research reports suggests that every % fall in rupee results in 6-7 basis points (1 basis point = 1/100 %) rise in inflation. Indian Rupee has already fallen by 12% in 2013.
Indian economy grew at decade low pace of 5%. Markets expect Central Bank to cut down key policy rates to support growth. But with inflationary pressures, depreciating rupee and high Current Account Deficit (CAD), RBI cannot cut interest rate. To solve these problems and revive growth, it is important to encourage people to save more and invest. Structural reforms of 1991 needs to be extended to bring India back on growing track. Newly appointed Governor, Mr. Raghuram Rajan will take charge from 5th September. Major challenges he will be facing in short term are to curb free-fall of rupee and reduce CAD. With elections coming closer, it is unlikely that govt. will cut down its public spending or will make major structural reforms. It will be interesting to see how he coordinates with Finance Ministry to tackle these challenges and revive growth.