Financing Public Expenditure on Imports in India under the New Economic Policy

Abstract

Fiscal Deficit Target which constitutes a cap on government’s borrowing has been a hallmark of the New Economic Policy (NEP) that India adopted in 1991 at the behest of IMF and World Bank. Tracing the trajectory of the expenditure pattern of the present Government of India, we have seen that there has been a steady rise in the government’s spending on imported armaments and imported capital goods. The aim of the paper is to consider the modes of financing of this enhanced government expenditure and the four different means of financing that we have considered are namely external borrowing, internal borrowing, taxation of capitalists’ income and indirect taxation. We have examined the short term macroeconomic impacts of all these four policies both in the presence of the fiscal deficit target and in its absence. We have found that the best way of financing the increase in the government’s expenditure on imported goods is by taxing the capitalists’ income in the presence of the fiscal deficit target. We have also found that the fiscal deficit target produces strong recessionary effects in the cases of internal and external borrowings. It acts as an automatic destabilizer in the cases of direct and indirect taxation. This paper therefore builds a strong critique of the ideological orthodoxy of the fiscal policy of the NEP pursued in India.