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Does Growth Lead to Debt Sustainability? Yes, But Not Vice-Versa! 77

government debt-to GDP ratio and improved sovereign debt ratings (Frankel, 2011). During the
copper boom of 2003-2008, despite high copper prices leading to higher export earnings and
economic growth, counter cyclical fiscal policy led to a budget surplus of almost 8 per cent and
government debt reducing to mere 4 per cent of GDP. During the subsequent phase of Global
recession when the copper prices had fallen, the government adopted unprecedented expansionary
policy (using the surpluses accumulated during the copper boom) to mitigate the effects of the
crisis (budget deficit crossed 4 per cent of GDP).

Figure 28: Counter-cyclical fiscal policy by Government of Chile (2000 to 2019)

Source: IMF
The strength of fiscal rules based upon potential GDP however, depends on the accuracy of
estimated potential GDP. When potential GDP is estimated accurately, a structural balance rule
ensures a counter-cyclical fiscal policy and leads to a gradual reduction in the debt-to-GDP ratio.

2.43 During economic crises, a well-designed expansionary fiscal policy stance can contribute
to better economic outcomes in two ways. First, it can boost potential growth with multi-year
public investment packages that raise productivity. The multi-year nature of public investment
would contribute to credibly lifting growth expectations. With the National Infrastructure
Pipeline (NIP) already laying out the agenda for ambitious public spending, fiscal policy
catering to funding NIP in the first few years can boost growth and thereby be self-financing
(DeLong and Summers, 2012). At a time of excessive risk aversion in the private sector, which
is characteristic of any economic crisis, risk taking via public investment can catalyse private
investment and unleash a virtuous circle. It will crowd in private investment, rather than crowd
it out. Second, there is a risk of the Indian economy falling into a low wage-growth trap, as has
happened in Japan during the last two decades. Implementing the NIP via front-ended fiscal
spending could generate higher-paying jobs and boost productivity.
2.44 The experience of Chile in implementing fiscal rules that enable counter-cyclical fiscal
policy is quite informative in this context (see Box 8 for details). As estimation of potential
growth can become challenging to implement such fiscal rules, it would be practical in the
Indian context to frame fiscal rules so as to allow space for fiscal policy to respond to slowdowns
in growth. The National Bureau of Economic Research (NBER) defines a recession in the
United States as two consecutive quarters of decline in GDP. Given the average growth and the
standard deviation of growth in the United States, negative growth corresponds to a 1.5 standard
deviation decline in growth. Similarly, a 1.65 standard deviation decline in growth, would a
priori manifest once in ten quarters or with a probability of 10 per cent, equals 3.5 per cent.