Moderation of retail inflation has come as a major positive in the run-up to the budget. It may help the monetary policy committee (MPC) to revise down its inflation projections.
However, it is highly unlikely to tempt RBI to provide fresh monetary stimulus. The market can get a hint of it from the monetary policy committee's minutes. Most of the committee members, in their last meeting, have opined in favor of returning to policy normalization as soon as possible.
If the RBI opt for policy normalization, it will start moping up the access liquidity from the market. In this context, the onus will be on the government to maintain the momentum in the economy. Here's where its approach towards fiscal spending is going to be crucial in the upcoming budget.
Monetary vs fiscal policy
For the uninitiated, monetary policy refers to the central banks' actions to control liquidity in the market. They use monetary policy to stabilize economic growth and control inflation.
The fiscal policy falls under the ambit of the government. It refers to boosting growth through government spending. The aim is to spend revenues efficiently to boost economic activities.
Extending fiscal support is a must but challenge are in plenty:
During the pandemic, the RBI has managed the economy by maintaining high liquidity in the system. It also allowed the government to shield its revenues. Direct fiscal stimulus from the Indian government was at the lowest globally.
Now that the central bank is now unable to stretch its resources. Hence, the role of prudent fiscal spending has amplified to maintain the momentum in the economy.
While there is a compulsion on one side to increase spending, Covid-19 has posed some formidable challenges for the Indian government. India's fiscal deficit is expected to reach at 7-8% of GDP in FY21 as against the target of 3.5% set in the previous budget.
Expanding fiscal spending is going to be difficult under these circumstances.
The government also needs to revive the private investment which has fallen to decadal lows. If private spending picks up, it will release the pressure from the government to an extent.
The merits of fiscal spending:
Government spending always trickles down to the weaker sections of the society. For example, it comes in form of soft infrastructure development (such as education, healthcare and public security) and hard infrastructure (such as mobility, power, water etc). It creates an efficient model for economic growth.
Better fiscal spending also creates employment opportunities. It is always a better option than providing subsidies or other unemployment benefits to the poor.
Monetary stimulus, on the other hand, are always seen benefiting rich households disproportionately. It often results in inflating assets, benefiting the rich households. We are currently witnessing the same situation in the equity markets.