burden eats into the resources available for discretionary expenditure. importantly, it crowds out the private sector from the debt market, inhibits private investment and affects future production capacity. fiscal deficit can also spill over and trigger balance of payments pressures as indeed happened in india in 1991. 63. by far the biggest concern stemming from a large fiscal deficit, especially from the reserve bank ’ s perspective, is that it adds to aggregate demand and thereby to inflation pressures. by crowding out the private sector, fiscal deficit could also inhibit, if not impair, monetary policy transmission to the private sector. credible fiscal consolidation is, therefore, a necessary pre - condition for stabilizing inflation and securing non - inflationary growth. bis central bankers ’ speeches fiscal consolidation and growth 64. there are some concerns, admittedly marginal, that fiscal consolidation in a sluggish growth environment will only dampen growth further thereby adversely impacting revenues and pushing the economy into a vicious downward spiral. there is some validity to this argument. but a growth slow - down on account of fiscal consolidation is not unavoidable. growth slow - down can be mitigated, indeed growth can be aided, provided attention is paid, along with the quantum of fiscal adjustment, also to its quality. experience demonstrates that even if total expenditure as a proportion of gdp is curtailed, it need not dampen growth ; on the contrary, if there is switching from current expenditure to capital expenditure, fiscal consolidation can actually stimulate growth by “ crowding in ” private investment. 65. empirical estimates for india validate this finding – even in a context of decline in total public expenditure as a proportion to gdp, fiscal consolidation can improve medium - term growth prospects if government increases capital spending, offsetting the moderating impact of growth in the short - term. these results reflect the higher long - run fiscal multipliers for capital expenditure and very low long - run multipliers for current expenditure. 66. the economics of fiscal consolidation are quite straight forward. the complexity arises from the political economy. tax increases and expenditure compression – the two strands of fiscal consolidation – are never politically popular, especially in democracies where political executives, virtually everywhere in the world, are characterized by high discount rates. they are much more tempted by short - term political pay offs rather than long - term sustainability. fiscal consolidation, by definition, is a long - term game. in the short - term political costs may exceed benefits ; in the long - term,

the economic and political benefits far outweigh any costs. it is this congruence of economic and political virtue that must inform fiscal consolidation. summing - up : india growth story intact 67. let me now sum up. i have spoken to you about the following three macroeconomic challenges confronting india and i have given you the reserve bank ’ s perspective on them. ( i ) managing the growth - inflation dynamics ( ii ) mitigating the vulnerability of the external sector ( iii ) managing the political economy of fiscal consolidation 68. these are formidable challenges, but by no means insurmountable. for people who despair, it is important to remember that the drivers of the india growth story – get up and go entrepreneurism, the demographic dividend, a large and growing middle class, the opportunity for productivity catch up, democracy and a decent legal system – are all intact. 69. the 12th five year plan aims at a growth rate of 8. 2 per cent for the plan period ( 2012 – 17 ). growth at this pace is the minimum necessary. indeed, india needs to grow even faster, at a sustained double digit pace, if it has to pull hundreds of millions of people out of poverty. the india growth story has all the ingredients to deliver on this promise. 70. but the india growth story is not inevitable. it will not materialize in the absence of vigorous and purposeful structural and governance reforms. it is those reforms that must continue to engage our attention. bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches