Friday, 5th July 2024

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RBI’s Surplus: To Spend or Not to Spend

Daily Current Affairs

RBI’s Surplus: To Spend or Not to Spend


Why in the news?

  • With a new government in office, attention has turned towards the Union Budget for 2024-25. 
  • A significant development preceding this budget is the Reserve Bank of India's (RBI) announcement of a substantial dividend transfer to the government, exceeding initial expectations.

Fiscal Management Principles & Purpose:

  • Fiscal Management Principles:
    • Prudent Deficits: Fiscal management should ideally maintain deficits around 3% of GDP for the Centre, as stipulated by the Fiscal Responsibility and Budget Management (FRBM) Act.
    • Cyclical Spending: Governments should adjust spending based on economic conditions—increasing during downturns to stimulate demand and scaling back during recoveries to prevent inflationary pressures.
  • Purpose: 
    • The objective of varying deficits is to stabilise the economy by supporting demand during economic downturns and controlling inflation during periods of recovery.
    • Symmetric policies are crucial—larger deficits during downturns should be followed by smaller deficits to stabilise government debt.

India’s Fiscal Challenges:

  • Historical Context of Fiscal Deficit:
    • India's average fiscal deficit from 2000-01 to 2019-20 was 4.6% of GDP, above the FRBM Act's 3% target.
    • Despite legislative efforts, adherence to the 3% norm has been challenging due to economic needs and developmental pressures.
  • Structural Issues and Economic Pressures:
    • Challenges include a large population, developmental demands, and limited tax base efficiency.
    • These factors contribute to persistent borrowing and fiscal deficits.
  • Pandemic-Induced Challenges:
    • The COVID-19 pandemic exacerbated fiscal pressures, leading to a high deficit of 9.2% of GDP in 2020-21.
    • Government intervention was necessary to support the economy during the crisis, impacting fiscal targets.
  • Post-Pandemic Fiscal Policies:
    • Efforts to reduce deficits post-pandemic have been gradual, with the 2024-25 Interim Budget targeting a deficit of 5.1%.
    • Balancing economic recovery with fiscal discipline remains complex.
  • RBI’s Unexpected Dividend and Debate on Capital Expenditure (Capex)
    • The RBI's Rs 2.11 lakh crore dividend to the government has sparked discussions on utilising this windfall.
    • Some suggest increasing capital expenditure (capex), although the Interim Budget plans indicate a slowdown in capex growth for 2024-25.
    • Critics argue against increased capex, cautioning against hasty spending decisions despite the surplus dividend.

The General Sentiment on Capex, Purpose of Capex Spending, and the Assessment of the Necessity of Capex:

  • The General Sentiment on Capex
    • There is a widespread belief in India that any expenditure on Capex is positive news, which may not always be accurate.
    • China, for instance, faced challenges after undertaking extensive infrastructure projects, such as multiple airports in the same city, leading to debt repayment struggles.
    • India needs a strategic approach to determine the necessary amount and type of Capex required.
  • Purpose of Capex Spending
    • Governments engage in Capex for two primary reasons: to stimulate economic growth and to address infrastructure needs.
    • While India faces significant infrastructure challenges, the approach should prioritise sustainable development over rapid expansion.
    • Post-pandemic, India has seen Capex grow annually by approximately 30%, raising questions about the sustainability and focus on new projects over maintenance.
  • Assessing the Necessity of Capex
    • Not all Capex contributes equally to economic growth. 
    • For example, investing Rs 1.6 lakh crore to revitalise state-owned telecom companies MTNL and BSNL may not be critical, especially with private operators providing affordable cell phone services nationwide.
    • Similarly, large investments in projects like bullet trains, given India's relatively low per capita income (less than $2,500), may not be economically justified.

Way Forward: 

  • The government should assess whether economic stimulus is necessary given the current strong economic performance.
  • Instead of increasing spending, the surplus dividend from the RBI could be utilised to reduce the fiscal deficit closer to the targeted three per cent of GDP.
  • It's essential to accurately gauge the true state of the Indian economy; if growth figures are inflated, there may be a case for continued government spending to support economic stability.

Conclusion:

India faces a complex fiscal discipline challenge due to structural issues worsened by economic shocks like COVID-19. Efforts to control the fiscal deficit have been made, yet persistent high deficits and growing debt underscore the necessity for deeper structural reforms and a steadfast commitment to fiscal prudence. Achieving this balance is critical to ensuring sustained economic stability and fostering long-term growth.

UPSC Civil Services Examination, Previous Year Questions (PYQs)

Prelims

Q1. If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do (2020)

  1. Cut and optimise the Statutory Liquidity Ratio
  2. Increase the Marginal Standing Facility Rate
  3. Cut the Bank Rate and Repo Rate

Select the correct answer using the code given below:

  1. 1 and 2 only
  2. 2 only
  3. 1 and 3 only
  4. 1, 2 and 3

Ans: (b)


Q2. With reference to Indian economy, consider the following: (2015)

  1. Bank rate
  2. Open market operations
  3. Public debt
  4. Public revenue

Which of the above is/are components/ components of Monetary Policy?

  1. 1 only
  2. 2, 3 and 4
  3. 1 and 2
  4. 1, 3 and 4

Ans: (c)

Source: IE

Keywords: GS-3, Economy - Growth & Development- Fiscal Policy- RBI
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