These days, the argument against a government stimulus is based on keeping the twin deficits (fiscal and current account) in check. It runs as follows: Since the current account deficit is the gap between savings and investment, it follows that the gap is best reduced by reducing government dissavings, or the fiscal deficit.

But if growth — which touched a 10-year low of 5 per cent in 2012-13 — dips due to cutbacks in government spending, savings may fall further and widen the current account gap. This is a classic case of a demand crunch creating a downward spiral — and is, in fact, happening.

The effects of sluggish capital formation since Q2 of 2011-12 (it has fallen even below 2008-09 levels, which was a crisis year) are already upon us, in the form of a deceleration in private consumption expenditure last fiscal.

In other words, it seems that job cuts are affecting spending, a fact borne out by the latest NSSO employment data.

The RBI observes in ‘Macroeconomic and Monetary Developments 2012-13’, released on May 2: “Sales growth for listed Non-Government Non-Financial companies moderated in Q3 of 2012-13 to its lowest level since Q3 of 2009-10.”

Lower revenues will lead to lower investment and still lower jobs and demand for goods. This is the story behind the low growth in 2012-13. The demand slack was made worse by the government squeezing capital expenditure to contain its fiscal deficit. The RBI subtly points to this mistake.

The private sector remains investment-averse despite a 125 basis points cut in policy rates since April 1, 2012. Its burden of debt, together with poor demand, has contributed to the problem.

The government should have taken counter-cyclical steps last year — just as it did in 2009-10. Such spending would not have been inflationary if it had created assets.

Fears of a higher fiscal deficit crowding out private investment are not relevant today, as the sentiments are weak. The important thing now is to get investments started.

Will a fiscal stimulus derail the government’s finances?

The RBI says in its May 2 report: “A public investment stimulus is needed to revive demand, but it is important to first create the fiscal space for it…”

As the Budget 2013-14 targets suggest, this can be done by pruning non-Plan revenue expenditure, chiefly subsidies, while increasing capital expenditure.

Just as the Golden Quadrilateral project, launched in 2001, created conditions for high growth between 2005-06 and 2010-11, the government can give a push to rail infrastructure.

By complying with land acquisition and environment norms, the government can counter the notion that such regulations are inimical to investment. A change in perception can usher a positive investment climate.

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