“In an economy that is overleveraged to historic proportions, economic stimuli may not do the trick.”– Kenneth Eade
Several governments across the world have announced fiscal stimulus measures to help their respective economies stay afloat. India, with large swathes of people facing the risk of infection, has nothing significant so far to show to the world. The government and the RBI are still weighing their options to hand out a stimulus.
What is a Fiscal Stimulus?
A ‘stimulus’ is an attempt by policymakers to kick-start a sluggish economy through a package of measures. A monetary stimulus will see the central bank expanding money supply or reducing the cost of money (interest rates), to spur consumer spending. A fiscal stimulus entails the Government spending more from its own coffers or slashing tax rates to put more money in the hands of consumers.
Need for a fiscal stimulus
With monetary policy, both conventional and unconventional, having reached the limits of its effectiveness in most of the advanced industrial countries, the only instrument left for boosting demand is fiscal policy. There are calls for a government stimulus package to revitalize the economy.
(1) Powering the Demand
- When demand in an economy stays weak for long, businesses stop investing in new projects, unemployment rises, income shrinks and consumer confidence wanes. This prompts consumers to retreat further.
- A stimulus could shot to consumer spending; it revives business confidence, restarts projects, creates jobs and sets off a virtuous cycle of feel-good, demand and growth.
(2) Boosting the Employment
- Many people have lost their jobs or seen their incomes cut due to the coronavirus crisis.
- Unemployment rates have increased across major economies as a result.
(3) Risking away the recession
- The IMF says that the global economy will shrink by 3% this year. It described the decline as the worst since the Great Depression of the 1930s.
- If the economy has to grow, it generally means more wealth and more new jobs and more spending, which is difficult without a stimulus package.
(4) Business resumption
- The COVID-19 pandemic came as a major blow to almost every sector of our economy and has created a credit-crunch. With most business permanently shut, others are crippled and reluctant to resume their business.
- Almost all manufacturing industries were affected by the crisis. Pharma was actually identified as one of the very few “winners”, while motor vehicles were (and continues to be) one of the biggest “losers”.
Precautions necessary before ANY stimulus decision
Today’s stimulus measures have understandably been rolled out in haste — almost in a panic — to contain the economic fallout from the pandemic. Bad policies can contribute to inequality, sow instability, and undermine political support for the government precisely when it is needed to prevent the economy from falling.
(1) Fear of liquidity trap
- During periods of deep uncertainty, precautionary savings typically rise as households and businesses hold on to cash for fear of what lies ahead.
- A liquidity trap is a situation in which, “after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash.
- Without a massive injection of emergency liquidity, there probably would have been widespread bankruptcies, losses of organisational capital, and an even steeper path to recovery.
(2) Inflationary outcomes
- The fiscal response is driven by the need to arrest a major slowdown in economic growth. However, there could be medium-term risks to the future inflation path, in the absence of timely fiscal consolidation.
- A sudden spike in demand is highly inflationary in nature.
(3) Strain on the exchequer
- Fiscal stimulus is warranted especially expenditures on health, food and income support for vulnerable households, and support for businesses.
- This is likely to have a considerable impact on the government exchequer and the overall expenditure of the government on key sectors.
(4) Deterioration of public finances
- India’s fiscal deficit in 2019-20 stood at around Rs 7.7 lakh crore, i.e. 3.8% of GDP. Hence, India’s fiscal room to opt for a massive stimulus appears much more limited.
- Any aggressive stimulus spending will not only result in a surge in India’s gross public debt but will also negatively impact its credit ratings, highlighting the country’s fiscal conundrum.
India’s response to pandemic
The COVID-19 pandemic has laid bare our pre-existing fault lines and exposed the country to an unprecedented crisis. This situation has led to bold policy measures by governments at all tiers.
The Indian fiscal response is thus much weaker than what has been seen in advanced economies, but it is broadly in line with the average for emerging markets.
|Economic Relief Package under Pradhan Mantri Garib Kalyan Yojana worth Rs 1.75 lakh crore (roughly 0.8% of the GDP).||Repo rate and Reverse Repo rate reduced to 4.4% and 4% respectively on March 27 in an effort to boost liquidity into the system.|
|Direct food, cooking gas and cash transfers to selected sections of the lower-income households.||Liquidity measures worth Rs 3.7 trillion via Long Term Repo Operations (LTRO) and a reduction of 100bps in Cash Reserve Ratio (CRR).|
|Insurance coverage for workers in the healthcare sector and wage support to low wage workers in terms of benefits for those currently working, as well as those who might lose their jobs.||Provided relief to customers and lenders by granting a 3-month moratorium on loan repayments. SEBI has also relaxed its norms related to debt default on rated instruments.|
|Additional Rs 150 billion (roughly 0.1% of GDP) to be devoted to health infrastructure. Several measures to ease tax burden, including postponing compliance deadlines.||Second round of measures which include Rs 50,000 crore liquidity for NBFCs and MFIs via TLTRO 2.0, Reverse Repo rate reduced to 3.75% to kickstart investments, WMA limit for state governments increased.|
PM also announced Rs. 20 lakh crore packages for farmers, cottage industry, MSMEs, labourers, middle class etc., titled the Atmanirbhar Bharat Abhiyan in various tranches. These measures contain both fiscal and monetary measures combined into a single package.
International experience with the stimulus
India has surpassed almost all others in the stringency of its containment measures. However in terms of expenditure, India’s response isn’t that promising.
- India’s fiscal stimulus to date, estimated at ₹1.7 trillion, is less than 1% of the country’s GDP, which is paltry compared to the magnitude of stimulus injections undertaken by many East Asian countries such as Japan (20%), Malaysia (16.2%) and Singapore (12.2%).
- Even, Vietnam, Indonesia, Pakistan, and Egypt, all while averaging less stringent measures than those in India, have announced stimulus measures that are as large or more substantial, as a share of GDP.
- Countries have also significantly expanded coverage of their cash transfer programmes from pre-COVID-19 levels; Bangladesh and Indonesia have increased the number of beneficiaries by 163% and 111%, respectively. Indonesia’s cash schemes now cover more than 158 million people (or 60% of the population).
- Developing countries are resorting to drastic means to finance COVID-19 responses. Actions so far include the amendment of legal budget limits and the enhanced issuance of bonds — including a ‘pandemic bond’ by Indonesia.
- Many developing countries have a dual strategy of providing immediate aid to workers who have been laid off and feeding poor families, while also trying to keep firms afloat. Indonesia, Vietnam, Bangladesh and China have all announced tax relief — in the form of deferments or reductions — for small and medium-sized enterprises (SMEs) in hard-hit regions.
- Brazil has also created a $10 billion (₹760 bn) programme to allow businesses affected by COVID-19 to reduce workers’ salaries and hours by up to 70%, with the government partially compensating workers for up to three months.
- One important omission from the Indian response is such direct wage support for micro, small, and medium enterprises, which account for the bulk of employment.
While we might not be able to match these advanced economies in terms of financial resources, we can implement policies on a similar scale.
“It is important that we note the weaknesses in our financial system, and work toward implementing solutions before the next crisis roars.”
Analysis of India’s response
The whole world is commending India’s efforts and bold initiatives that have prioritized “life over livelihood”. Based on the figures, it is safe to say that India has spent a lot less, especially on the fiscal front in terms of stimulus packages introduced by governments, as compared to other countries.
One might argue that these responses cannot be compared to each other due to two main reasons.
- First, the number of cases as well as the rate at which they are increasing is much less in India due to the early implementation of lockdown.
- And second, India’s economy is much more different than the ones whose data has been mentioned above, so it is not at all necessary for the same measures to be effective for our country as well.
However, the economic crises faced by all these countries do share some common ground. Here’s what we can derive from this data:
1) Sectors like small businesses and MSMEs have been adversely affected by this crisis in all countries irrespective of how developed they are. India is yet to address their issues directly; hence, a strong assumption is that we will soon see measures from the government’s side to provide them with some relief.
2) India’s healthcare system is hardly as developed and advanced as in the above-mentioned countries. And yet, the amount these countries have allocated to this sector is much higher.
3) Unemployment is on the rise everywhere. A report by the ILO said that more than 40 crore Indian workers in the unorganised sector are expected to lose their jobs. Hence, printing more money in order to give it directly to people in these times as income, something which is already being done in countries like the US and UK, is worth considering for India as well.
4) Special focus has been given to worst affected industries like airlines, travel and e-commerce in these countries. We are yet to see something similar in India.
Moving ahead: India needs to spend more
- Under the ambit of fiscal policy, first, the government should front-load its $250 billion spending plan under the National Infrastructure Pipeline.
- Second, it should announce a sizeable package to compensate, at least partially, the irrecoverable loss of income suffered by the Indian industry, be it big, small, or medium.
- Third, this is an opportunity for India to position itself as the next global manufacturing hub in sectors such as textiles, food processing, pharma, and metals (particularly steel). Trade, tax and investment policies should be calibrated accordingly to achieve this.
Under the ambit of monetary policy, following steps can amplify the impact of fiscal measures.
- First, banks must extend term loans and working capital to Indian industry with a government backstop for the first loss up to 25%. The government needs to provide credit protection to the banking system.
- Second, banks should have discretion and flexibility to undertake loan restructuring aimed at ensuring the stability of operations across several sectors.
- Third, a sharp reduction in lending rates is imperative. While the policy rate has fallen by 210 basis points, transmission to industry has been less than 60 basis points.
- Fourth, banks must defer loan and interest payments by at least one year, as industry needs time to generate free cash flows.
Three T’s for optimum impact
To have the greatest impact with the least long-run cost, the stimulus should be timely, temporary, and targeted.
- Timely, so that its effects are felt while economic activity is still below potential; when the economy has recovered, the stimulus becomes counterproductive
- Temporary, to avoid raising inflation and to minimize the adverse long-term effects of a larger budget deficit, and
- Well-targeted, to provide resources to the people who most need them and will spend them: for fiscal stimulus to work, it is essential that the funds be spent, not saved.
We can hope that the above steps are taken expeditiously and translated into action on the ground to reboot the Indian economy at the earliest.
In conclusion, the ongoing debate might be a misleading factor to judge our response to this crisis. And it definitely doesn’t mean what we’re doing is enough. This crisis happens to be an uncertain and unprecedented one; holding back on spending clearly doesn’t seem to be an option for the Indian government right now.
Maintaining the overall fiscal discipline, the government must not worry about the fiscal deficit, as reviving the economy is the need of the hour, even if it comes at the cost of high inflation, though such an outcome is unlikely.