Press Release

Rethinking Fiscal Rules in Times of Economic Uncertainties: Pinaki Chakraborty

Published on 01.04.2024

Centre for Socio-economic and Environmental Studies (CSES), Kochi is pleased to release of CSES Working Paper titled “Rethinking Fiscal Rules in Times of Economic Uncertainties”, authored by Professor Pinaki Chakraborty, renowned expert on public finance and former Director of the National Institute of Public Finance and Policy (NIPFP), New Delhi.  Prof. Pinaki’s paper highlights that post-COVID fiscal consolidation is emerging as a major issue as countries deal with large deficits and debt, high inflation, and uneven economic recovery. Though in the short run, necessary flexibility for creating fiscal space needs to be provided through higher borrowing, there is a need to return to sustainable fiscal management for macro stability and growth in the medium term. The argument that long-run debt sustainability should always be focused on growth recovery is relevant for advanced economies and emerging market economies like India. Further, the author cautions how rising debt has the potential to reduce fiscal space for development spending and stresses the need to achieve a fine balance between fiscal expansion and stability.

Major points discussed in the Working paper are noted below. 

The global economy is facing unprecedented challenges of growth slowdown in 2022 and 2023, elevated levels of debt and deficit, rising cost of fuel and other intermediate commodities resulting in sharp rise in prices, and serious disruption in supply chain due to the ongoing war between Russia and Ukraine resulting in shortage of essentials like food and energy in some parts of the world. The fear of a prolonged global recession is looming large. More importantly, post-COVID recovery of economic growth is highly uneven across regions, which has implications for fiscal policy, revenue mobilisation and debt sustainability.

Increasing fiscal risks in the context of rising macroeconomic uncertainties have generated new discussions on the nature of fiscal rules to be adopted by countries.Though, in the short run, necessary flexibility for the creation of fiscal space needs to be provided through higher borrowing, there is a need to return to a sustainable fiscal management for macro stability and growth when we take a medium-term view. The economic shock in terms of GDP contraction due to the COVID-19 pandemic though reversed in the fiscal year 2021-22 for major advanced and emerging market economies including India, a stable and sustained recovery is needed.

 The increase in the debt to GDP ratio across countries have resulted in a reassessment of the conventional wisdom on fiscal rule and the accumulation of public debt. The long run debt sustainability should always be focused on growth recovery, interest rate, and the level of debt. The quantum of fiscal shock and the time required for readjustment requires clear assessment. 

The paper notes the difficult situation, time required to reduce debt, while the management of inflation cannot wait and available options being complex. Going forward, the global economy needs a coordinated policy for monetary tightening and fiscal sustainability. There is a need to start fiscal normalisation without creating adverse distributional consequences. For this, countries need to chart out a fiscal normalisation plan to ensure that it is not abrupt, and responses are sequenced in a manner that helps bring the economy back on track, enhance fiscal resources for the government for public investment in the social and economic sector and create a framework for sector-specific differentiated responses for a full recovery.

The money spent by low-income developing countries to deal with COVID-19 was far less than the advanced and emerging market economies and most of this spending was on health and emergency response. Rising debt and inflation are only going to compound macro challenges for these countries. There is a need for a quick and efficient resolution of the challenges arising due to the elevated debt levels of low-income countries. One can hope for an equitable, fair and sustained recovery post-COVID only when there is greater international cooperation to ensure more resource flow to the poorer regions of the world and a credible fiscal recovery plan.

For more information, please contact Dr. Rakkee Thimothy, Fellow, CSES: Mob. 9873101227.