Economic Indicators and Various Reports On It- GDP, FD, EODB, WIR etc

Government must fix an upper limit for fiscal deficit

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much.

Mains level : Paper 3- Need for the stimulus and relief package to in the wake of Covid-19 and issues involved in its size.

D. Subbarao in this article discusses how the government is facing the hard choice of choosing between saving lives and saving the economy. On the government’s response on economic front he argues that the government, unlike the rich countries should keep an upper limit on its spending because of the dangers involved in unrestricted spending.

Why the dilemma is sharpest for India?

  • This dilemma is arguably the sharpest for India.
  • Because of our high population density and poor medical infrastructure, any laxity in prevention can result in a huge health disaster.
  • On the other hand, an extended lockdown will force millions into the margins of subsistence, push small and large firms alike into bankruptcy, seriously impair financial stability and land us in a humanitarian and economic disaster.

Why is the relief package criticised as too little?

  • After the lockdown, the government announced a relief package amounting to 0.8 per cent of GDP, that’s been criticised as being too little.
  • From a study of a sample of countries, the latest issue of The Economist reports that India’s lockdown has been the most stringent while its fiscal relief package is the smallest in proportion to GDP.

What could be the reasons for a cautious approach in the relief package?

  • A possible explanation for the government’s timid fiscal response may be the fear of spooking the market.
  • For years, every economist and analyst has been warning the government of the dire consequences of fiscal irresponsibility.
  • And that warning message must have been so hardwired into the government’s collective mind that it was unable to get over the mental overhang.

We should be aware of the reasons from the macroeconomic point of view that force the government to limit its fiscal deficit. In this case, India government is exercising the caution owing to the same constraints.

Uncertainties in the crisis

  • Uncertainty is a defining feature of every crisis.
  • During the global financial crisis, a big uncertainty around the world was about how much risk there was in the system, where it lay and who was bearing it.
  • The uncertainty of the corona crisis is much deeper.
  • There are far too many known unknowns not to speak of unknown unknowns.
  • Uncertainties in corona crisis: We just don’t know enough about the effectiveness of the lockdowns, the age and gender profile of susceptibility to the virus.
  • We also don’t know about the process of recovery, the tipping point if any for mass immunity, whether the virus will attack in waves.
  • And most importantly, when we might have a vaccine and a cure.
  • Governments are, for the large part, having to fly blind.

Issues over relief and stimulus package

  • There are many issues to be decided and planned on the way forward.
  • A big issue will be an expenditure plan for relief during the crisis and stimulus after some normalcy is restored.
  • Borrow more spend more: Even the most ardent fiscal hawks are now agreed that the government needs to abandon its fiscal reticence, and borrow more and spend more.
  • Even the most extreme monetary purists are agreed that the RBI should fund the government borrowing by printing money.
  • Even the staunchest advocates of financial stability are agreed that more regulatory forbearance is necessary.
  • And virtually everyone is agreed on where additional spending should be directed.

Debate on how much additionally the government should borrow

  • There is disagreement on how much additionally the government should borrow.
  • There are two opposing views in this regard, which are discussed below.
  • 1. Fiscal risk without preset fiscal deficit: One view is that the government should err on the side of taking a fiscal risk without any preset fiscal deficit number.
  • It should simply determine what needs to be done and borrow to that extent, acting as if there were no fiscal constraint at all.
  • In other words, act as per the diktat of the now famous three words — “whatever it takes”.
  • 2. Set a limit: An opposing view is “whatever it takes” is not an option for India.
  • Many analysts have estimated that just the loss of revenue due to the economic shutdown will take the combined fiscal deficit of the Centre and states beyond 10 per cent of GDP.
  • The borrow and spend programme will be in addition to the above loss.
  • Unlike rich countries, we can’t afford to ignore the risks of fiscal excess of that magnitude, no matter the compelling circumstances.
  • What are the risks involved? There will be a heavy price to pay down the road by way of inflation and exchange rate volatility.

From the UPSC point of view you must pay attention to the both the arguments made here, question can be asked in UPSC based on the suggestions and their pros and cons. Both the arguments cited above have their merits and demerits.

Way forward

  • It’s important to keep in mind that we have resources and capability in the near future should there be another wave of the virus later in the year.
  • It will be advisable for the government to fix an upper bound for fiscal deficit and operate within that. For now, the borrow and spend programme should be restricted to 2 per cent of GDP.
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