Any talk of a fiscal stimulus is sure to make the purist amongst economists raise a red flag. Even policy-makers begin to sound defensive when pushing fiscal expansion. However, historically, this term has been quoted out of context in India, and the current debate is no different. Even as there is talk that the government is planning a fiscal push to support growth, strong dissenting voices are suggesting that all hell will break loose. Comparisons are being made with the 2008 stimulus and dire warnings are being issued. We believe that there must be an impartial assessment of the current situation, and a fair comparison between 2008 and the current situation is required. It is our conviction that a counter-cyclical fiscal policy push is the need of the hour, and it should not be misconstrued as similar to the misguided fiscal policy of the past.
First, let’s put the numbers in context. The total size of the discretionary fiscal stimulus that India provided during 2008-2010 was 1.8 per cent of the GDP, much lower than its Asian counterparts and several other countries — Korea 9.4 per cent, US 4.9 per cent and China 6.2 per cent, and South Africa, 6.8 per cent among others. The stimulus per se was then not the main culprit behind runaway inflation and rupee panic, as some critics would have us believe. There were additional measures, including the debt waiver amounting to 0.9 per cent of the GDP, the Pay Commission’s recommendations, around 0.8 per cent of the GDP, and a staggering 22 per cent increase in the MSP during FY09-FY11, which together were responsible for the macro deterioration, not just the fiscal stimulus.
Second, there are important differences between then and now, even though the loan waivers (by various states, not the Centre), and the Pay Commission awards are common elements. The situation now is quite different. First, the Pay Commission’s recommendations as a percentage of the incremental PFCE (private final capital expenditure) are down to 9 per cent in FY17 from 22 per cent in FY09. This implies a less frothy boom in consumption. Second, unlike the earlier years, there are no arrears that have to be paid. Third, the loan waivers are unlikely to fuel inflation, as inflation has structurally corrected from double digits to low single digits in the last three years, and rural demand is now at multi-year lows. Fourth, procurement price increases in the last three years have been moderate and do not threaten inflation.
Fiscal expansion got a bad name because in India it has been largely pro-cyclical. This means that fiscal policy is expansionary (increasing spending/reducing taxes) in boom times and contractionary in recession. The opposite is true for counter-cyclical policy, which is more effective. Ever since the East Asian crisis of the mid-1990s, institutions like the IMF pushed fiscal austerity for the developing countries, especially when the debt situation worsened or fiscal deficit exceeded targets. Rating agencies too joined the chorus asking for austerity to combat rising debts and deficits. Such advice was quickly abandoned during the European debt crisis. The IMF even apologised that its earlier austerity advice was wrong. Malaysia, which had defied the IMF in 1997, had the last laugh. So obviously, an effective policy calls for a classical Keynesian approach, that is, countercyclical fiscal policy. This means that deficits should decline when the economy is expanding and increase during economic downturns.
The expert committee on Fiscal Responsibility and Budget Management, in its report, recommended numerical targets for debt and deficits. But it also provided an escape clause for deviating from the deficit target by up to 0.5 per cent of the GDP. One of the triggers for the escape clause was far-reaching structural reforms in the economy with unanticipated fiscal implications. Surely demonetisation, GST and RERA in quick succession should qualify for this criteria. They have created much short-term fiscal uncertainty.
It is, hence, imperative that we believe the government must go for a fiscal push. This is different from 2009. Policy should now focus on structural bottlenecks and not on putting money in the hands of consumers. The first of these is to recapitalise public sector banks through widely-discussed recapitalisation bonds that have precedence not only in India but also in many other countries (Korea and Malaysia, for example). The obvious advantages of such bonds are that they do not alter the fiscal maths. The government need not raise immediate tax revenues and by borrowing directly from the banking system instead of the markets, the Centre can avoid crowding out private borrowings or distorting market yields.
The fiscal package could also include sector-specific measures, such as on sectors like exports, telecom, construction and power. Last year’s textile package of support for wage costs and interest subvention could be expanded. Some successful state-level initiatives, as in the garment sector in Odisha, can be expanded nationally. Affordable housing offers another big opportunity. It has a big multiplier effect. It helps the construction sector and has the maximum employment elasticity. Another area is the resolution of stressed assets. It is high on the agenda of the government, and hence the National Company Law Tribunal infrastructure needs further ramping up.
Structural and deep reforms like GST, RERA, monetary policy framework and move to less-cash and digital economy, will all pay back over the longer term. However, they have created short-term uncertainties and disruption. This needs deft policy and perception management. The earlier NDA government took bold decisions like radically revamping the telecom policy (from fixed fee to revenue share) and launching the golden quadrilateral project, all of which have borne fruit in the longer term leading to sustained growth of over 9 per cent. The short-term fiscal measures will also bear fruit in the medium term.
Bigger reform in land and labour await us. Bigger spending also awaits us in urban infrastructure. India needs to correct imbalances in regional growth, and the urban-rural divide, and addressing the woes of the farm sector. There is much work to do, but for this year, we need a definite fiscal push.
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