TOPIC : TIME TO SHUN FISCAL ORTHODOXY

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THE CONTEXT: Unprecedented fall in GDP in the first quarter of current financial year has brought back the importance of fiscal policy into limelight. With monetary policy not producing the desired result; consumption and private investment expenditure remaining subdued, the onus of reviving the economy rests on the fiscal policy. The expansionary fiscal policy (huge government expenditure or a cut in tax rate) can bring about a visible and concrete change in the status of Indian economy.

The government is expected to shun the path of fiscal orthodoxy and make a meaningful expenditure to arrest the decline in GDP or income. Fiscal stimulus seems to be the need of the hour.

The present article analyses the rationale and feasibility of fiscal support that the economy needs to mitigate the impact of covid-induced recession.

REASONS FOR A FISCAL BOOST

• The unprecedented 23.9% decline in the gross domestic product (GDP) in the first quarter of 2020–21, mainly due to the stringent lockdown enforced after the COVID-19 outbreak, is the main reason demand for a massive fiscal stimulus has arisen.
• Taking into consideration the activities in the informal sector of the economy, the decline could be much larger than reported. This is because quarterly estimation of GDP does not capture informal sector which accounts for almost half of our GDP.
• The largest decline was in manufacturing, construction, and trade, hotels, transport, and communication where output fell by 39.3%, 50.3% and 47%, respectively. These three segments ­account for almost three-fourths of the total workers employed outside of agriculture and the sharp fall in output would have wiped out millions of jobs.
• Similarly, the expenditure-side numbers indicate a sharp fall in both consumption and investments. While private consumption, the biggest component, has declined by almost a quarter, the gross fixed capital formation or investment has almost halved. This urgently necessitates huge government stimulus.
• The economy had already slipped into a crisis even before the pandemic struck. In fact, the quarterly GDP has steadily decelerated for nineth consecutive quarters and brought down growth rates from a high of 8.1% in the last quarter of 2017–18 to a low of -23.9% in the first quarter of 2020-21. And, given the current trends, it can now be safely assumed that the GDP will shrink substantially, maybe even by double digits, in the fiscal year 2020–21.
• Historically, India’s GDP has shrunk four times since the early 1950s, with the sharpest and the most recent one being in 1979–80 when GDP declined by 5.2%. But, the current decline is both much more extensive and severe. There is a simultaneous fall in consumption, investments, and exports and only concerted and radical interventions by the government can ensure that the growth bounces back closer to double digits.
• The pandemic has also exposed many lacunae in the economy, especially in the health and social security network. very few informal workers in the economy, who account for around 92.4% of the total workforce, have any social security benefits like paid leave or other non-wage benefits that will help them tide over a crisis.
• International commitments towards SDG should also be reasons for enlarging government expenditure.

FISCAL RESPONSE SO FAR

The government’s response to the pandemic so far has been slow and inadequate.

Despite the havoc heaped by the pandemic, on both business and employment, and the millions of migrants fleeing to the safety of their villages, the government delayed any substantial relief till the third week of May. And, though the stimulus package announced in May 2020 was as large as `20 lakh crore, or around 10% of the GDP, most measures were focused on monetary policy interventions. Fiscal support was only a little more than 1% of the GDP. The government clung on to fiscal orthodoxy even as the economy suffered one of the biggest hits ever.

So, the burden of recovery was shifted largely on to the central bank, which steadily cut rates and pumped up credit flows to productive sectors. But, as consumer inflation steadily rose to exceed the central bank’s targets, mainly due to high taxes on fuel and bottlenecks in food supply, the Reserve Bank of India was soon forced to pause the rate cuts.

Many economists and commentators have mentioned that Government announcement on the stimulus of Rs 20 lakh crores tries to resolve only supply-side issues. There is nothing to bring in an additional demand.

INDIA’S FISCAL STIMULUS IS INADEQUATE AS COMPARED WITH DEVELOPED AS WELL AS ITS DEVELOPING PEERS

Across the world, country stimulus responses vary from 1 percent of GDP to 12 percent of GDP as of now. Rich countries seem to have announced larger stimulus packages (5 to 10 percent) and poor countries have announced smaller packages (2 to 5 percent). In case of India, it is a bit more than only 1 per cent of its GDP.

DO WE HAVE A FISCAL SPACE?

There is no denying the fact that the fiscal space with the government to deal with recession is limited. Corporate tax has already been cut and, now, with growth slumping into negative territory, the ability of the government to raise tax revenue in coming months would further get hampered.

In this dire situation, the increased expenditure on fiscal stimulus can be dealt with by raising market borrowings. India has already raised its estimated fiscal deficit from 7.8 lakh cr to 12 lakh cr.

DOES THE CENTRAL GOVERNMENT HAVE MORE CAPACITY TO BORROW?

Yes. The following points illustrate this;

• Surplus liquidity and limited private credit demand will ensure that government bond auctions remain well subscribed.
• India is running a current account surplus. That’s compounded by strong capital flows. So we have the pool of savings. Banks don’t want to lend to the real economy. There is a presumption here that those resources will ultimately be channelled into government bonds.
• In addition, the government can choose to roll-over the treasury bills issued in the first half of the year. The government has borrowed and issued close to Rs 5 lakh crore in treasury bills already. One way the government can finance more of its deficit is by rolling over those treasury bills.

Eventually, the extent to which the government can allow its debt burden to build up during the pandemic will depend on the expected trend growth in the economy.

If India’s growth is at 7% over the next five years, India can absorb a much larger stimulus this year and in the medium term, debt-to-GDP come down. If India’s trend growth settles at 5%, even a muted fiscal response this year will result in debt to GDP rising enormously. So we should not lose sight of the fact that trend growth matters a lot.

WAY FORWARD:

Government can carve out more fiscal space to boost spending without any downside risks. It must release funds through a multi-year asset sale programme.The public authorities in India have a good amount of shares in public sector undertakings (PSUs), public land, and foreign exchange reserves. There is scope and anyway a need for reducing public holdings of these assets.

Disinvestment:

The market return on investments in PSUs is very low and it is doubtful if even the social returns are large; there is a rationale for disinvestment or privatisation (Dutta 2010). Indeed, the GOI has been engaged in a disinvestment programme for quite some time.

Monetising Public Land:

public authorities in India hold excess land; 13 major port trusts have 100,000 hectares of land, the International Airports Authority of India has 20,400 hectares of (additional) land, the Ministry of Defence has 283,280 hectares of land, and the Indian Railways has 43,000 hectares that is valued roughly at a whopping Rs. 3 trillion, which is significantly more than the true fiscal component of the big financial package of about Rs. 21 trillion announced in May 2020. So, here again, we have a way to mobilise funds by selling excess land – more so when the market price of land in India is more than the fundamental value of land.

Forex Reserve:

Finally, let us come to the foreign exchange reserves with the RBI. These stand at US$ 560 billion or Rs. 42.5 trillion as on 30 October 2021 (this is about 2 times the size of the relief package announced by the GOI in May 2021). It has been argued that these reserves can be reduced significantly without endangering macro-financial stability.

All this suggests that the public authorities have considerable fiscal space if we consider their assets.

CONCLUSION:

Nobody is advocating that India does the kind of stimulus that the UK or Germany or other developed countries are able to adopt, because we don’t have the kind of hard currency that they have. However, a meaningful demand-driven expenditure could be made to turn the course of the economy.

• Basic income in terms of cash transfer to a selected group of people, like women, will go a long way in addressing the demand side .
• Government should spend on creation of social and economic infrastructure which will not only generate employment abut also crowd-in private investment.
• Building an efficient social security network to protect all workers from economic instabilities.
• Rolling out programmes to scale up medical coverage across the country to ensure better protection from future pandemics.

Clearly, the government’s efforts to provide relief and revive the economy have now reached a dead end, and the only way to kick-start a steady recovery is to launch a massive fiscal stimulus package to stem the fall and ensure a quick recovery.