The Stimulus Debate: Government Can Do More To Address The Demand Side Challenges When The Economy Opens Up
The only way to assess the five tranches of announcements is to not get into a debate on classifying the components of the economic package but by asking what impact it is going to have on growth.
Finance Minister Nirmala Sitharaman has unveiled the details of Rs 20 lakh crore stimulus package that aims at absorbing a part of the economic shock due to the global coronavirus pandemic.
There has been a debate ever since the package was announced on the component of cash outflow due to the package along with critics pointing out the need to revive demand. This makes it important to understand different aspects of the package.
The first question is on whether there is a problem of demand, as many have pointed out over the last few weeks.
The answer to that is we do not know. This is important as nearly 60 per cent of the economy is shut so there is neither supply nor demand of these products.
It could be the case that once lockdown is lifted, supply chains repair themselves and there is some component of the demand that is missing in the economy, especially for discretionary consumption.
Similarly, we know that some people have lost their jobs while others have experienced some form of wage cuts.
These factors hint at a lower than anticipated demand, but the extent and the sectors that will be hit will become clearer only once the economy opens up.
This is the precise reason why economist Dr Arvind Virmani has been advocating for the need to prevent financial contagion from spreading while a fiscal package must come only once the economy is opened.
The argument was also presented in a joint paper with me which can be accessed here.
The key point worth remembering is that Indian government has resource constraints that do not allow it to go excessively overboard with its fiscal spending. The lockdown comes with its severe costs even for the government as it finds limited taxation revenue from the goods and services tax (GST).
This problem gets compounded as the GST Act has a provision to compensate states for any revenue foregone and it assumes a 14 per cent growth rate in taxes over the years.
Therefore, even as growth slows down and central government finds its tax revenues dwindling, it may invariably have to compensate states for the revenue shortfall.
This in turn is for all practical purposes a stimulus as states would invariably end up spending this money.
They will also borrow more to meet any shortfalls due to the lower share of direct tax collections (from petrol, alcohol etc).
The other issue is what entails the Rs 20 lakh crore package; and why is the actual fiscal outlay lower than the prescribed amount.
The answer to this is simple, the government has adopted a prudent approach of using multipliers along with monetary policy and macro-prudential regulations to leverage its fiscal space and provide a sizeable stimulus.
A bulk of the countries have undertaken similar set of measures, including the UK and several other countries, which have used credit guarantees to provide companies with immediate cash to meet their expenses.
This is important as many are pointing out as to why credit is not a stimulus, however, a fundamental difference here is that this credit is guaranteed by the government and is subsequently collateral free up to an amount.
Therefore, the way to look at this is whether the credit would have been made available in the absence of these measures and unfortunately, the answer is no.
Besides, credit has the capacity to build modern economies and that is precisely why ensuring liquidity is important to prevent a financial contagion.
Apart from this, government has also provided for equity infusion and enhanced spending on Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) along with augmentation of healthcare infrastructure across districts,
Although, on MGNREGA, the government has to recognise the need to get migrant workers back to cities as it cannot afford to have them depend on public distribution system (PDS) and MGNREGA, which can become a significant fiscal drag in future.
The best strategy for now would be to use MGNREGA funds for the scaling up of piped water project, wherever possible to create productive assets while creating a policy to bring back these workers to their place of work.
This will be critical as without labour our industries may not be able to open on time and capitalise on the opportunity to forge backward and forward linkages with markets over the next few months.
The debate on stimulus has so far ignored the impact of preventing supply side contagion, which in turn will prevent the demand from going down.
If companies go bankrupt, people lose their jobs which in turn results in a higher unemployment, lower income and consequently demand.
It is, therefore, important to first prevent the supply contagion and once the economy opens up then a more nuanced approach can be taken towards further addressing the demand component of the crisis.
We must also concur to the fact that several state governments too will announce their own stimulus packages and a bulk of them would focus on addressing the demand side of the problem.
As stated in an earlier article, the only way to assess the five tranches of announcements are not to get into a debate on classifying the components of the package as fiscal, monetary and macro-prudential but instead asking the question regarding its impact on growth.
The package, if implemented in time does well on that front, however, one will have to wait for a while and therefore, I shall reserve my judgement on this one even as I’m optimistic about the recovery.
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