On May 12, Prime Minister Narendra Modi announced a relief package of Rs 20 trillion, about 10 per cent of the country’s GDP, for the economy in crisis. The news made a big splash. After Finance Minister Nirmala Sitharaman unwrapped this package in tranches, there is widespread disappointment among most stakeholders.
There is relief for agriculture in the form of a concessional credit line of Rs 2 trillion, but loans are neither automatic or assured, while marketing reforms and infrastructure creation are distant promises. The MSME sector, the backbone of the economy that provides 25 per cent of employment, 32 per cent of the GDP and 45 per cent of exports, is unhappy despite the Rs 3 trillion line of credit for loans without collateral. In their experience, lenders are not always supportive in extending loans, while buyers (central and state governments, public sector firms and the private sector) owe them as much as Rs 5 trillion. What is more, most MSMEs just do not have the resources to pay wages or meet fixed costs on electricity, rent or interest during the lockdown period.
There is nothing for the corporate sector in manufacturing or services. The distressed sectors such as airlines, automobiles, hotels, restaurants, and tourism have been ignored. Ironically, there is little for public health, already in a dilapidated state. Even stock markets, characterised by irrational exuberance in the past month, have dropped.
The poor or the migrants, caught up in their struggle for survival, might not have voiced their opinion so far on the grossly inadequate relief package for them, but the harsh realities of this period — hunger without jobs, incomes, shelter or dignity — will be embedded in their memories for long. This economic deprivation will have social and political consequences.
The big picture is lost in details, so that it is difficult to see the wood from the trees. There are statements of good intentions. There is a recycling of ideas or schemes from earlier budgets. There are policy reforms with a longer-term perspective. But there is little cohesive focus on stabilisation and revival of the economy in the short-run — so essential at this time.
The fiscal stimulus, which can be defined as government expenditure that could stimulate demand, is difficult to discern, because the package is neither clear nor transparent about the cost to be borne by the government in each component. Even so, there are 12 estimates by analysts in financial sector institutions, suggesting that the fiscal stimulus is in the range of 0.7 per cent to 1.3 per cent of the GDP.
My estimate of the fiscal stimulus (including the announcement on March 26) is Rs 2.66 trillion, which is 1.2 per cent of the GDP. Of this, however, Rs 0.9 trillion, or 0.4 per cent of the GDP, is from a drawdown on the existing funds available with state governments (Rs 0.67 trillion) and existing budget provisions (Rs 0.23 trillion). Thus, the effective fiscal stimulus, in terms of extra resources provided by the government, is Rs 1.76 trillion, or 0.8 per cent of the GDP. Its contribution to domestic demand will be minuscule, given that private final consumer expenditure in India is about 60 per cent of the GDP.
It is clear that the design of this relief package seeks to focus on the supply side, with an emphasis on providing liquidity through lines of credit, where the RBI is providing as much as Rs 8 trillion, rather than on the demand side by stepping up government expenditure, with the aim of minimising the cost to the government. The arithmetic is obviously imaginative — as much as Rs 10 trillion of the relief package will have to be financed by sources other than the Centre and the RBI. Where will resources to bridge this massive gap, 4.4 per cent of the GDP, come from?
This stress on the supply-side, while neglecting the demand-side, reveals a flawed understanding of economies in crisis and little recognition of the reality when a prolonged lockdown has brought the economy on the verge of collapse. Even in normal circumstances, the speed of adjustment of the supply-side is slow because supply responses take time, whereas the speed of adjustment on the demand-side is fast as incomes spent raise consumption demand without any time-lag. At present, if there is little or no increase in demand, supply responses will be slower than usual because producers would not wish to pile up inventories of unsold goods. In terms of the chicken-and-egg parable, demand must be revived first to kickstart the economy.
For this reason, the fiscal stimulus should have been much larger. But the decision-makers have been timid, intimidated by the prospect that, because of revenue shortfalls (2 per cent of the GDP or more), the fiscal deficit would be 5.5 per cent of the GDP exceeding the budget estimate at 3.5 per cent of the GDP. The conclusion drawn, wrongly, is that there is no fiscal space.
The obsessive concern about the fiscal deficit, so deeply embedded in government thinking, suggests a narrow and limited understanding of rudimentary macroeconomics, which has often gone wrong even in good times. It also reveals an utter failure to recognise that we live in unprecedented, extraordinary times with the world economy in a crisis that could be much deeper than the Great Depression 90 years ago.
In this situation, the extra fiscal stimulus should have been Rs 7-9 trillion (3-4 per cent of the GDP) and that would have been modest compared to what other countries have done. This enlarged fiscal deficit cannot be financed by market borrowing, which would simply drive up interest rates and nip recovery in the bud. It would have to be financed by monetising the deficit — RBI buying government T-bills — printing money, now termed “helicopter money”.
The idea that monetised deficits will unleash inflation is blind to the reality that, at this juncture, if there is no further intervention by the government, the GDP could contract by 5 per cent in 2020-21, with lingering consequences. In fact, a monetised deficit might be the only way of increasing aggregate demand to revive economic growth. The worry about a downgrade from credit rating agencies is bizarre. For one, their ethics and integrity have seen steady erosion. Moreover, how many sovereign governments will they downgrade? In fact, we might be better off without the footloose and volatile portfolio investment inflows.
If the government does not accept the necessity or wisdom of expansionary macroeconomic policies, it must set out its alternative plan for recovery. The relief package will not suffice. And, if the economy goes into a free-fall, the massive shortfalls in government revenues would balloon the fiscal deficit to similar or higher levels without any hope of recovery. The fiscal space will not be preserved. It will be squeezed further. It is time for the fiscal hawks in government to put on their thinking caps.
This article first appeared in the print section of May 23, 2020, under the title ‘An insufficient relief’. The writer is an economist and former Vice-Chancellor, University of Delhi