On June 28, finance minister Nirmala Sitharaman announced an economic package to deal with the adverse effects of the second wave of the pandemic. The contours of the package are similar to what was announced last year when the pandemic first erupted.
The actual fiscal cost is only a fraction of the headline number attached to the package. The bulk of the support is in the form of credit guarantees, which means the government only pays in case there is a credit default. This approach is different from what most major economies have adopted, where the fiscal component was a much bigger part of the stimulus.
Will this approach work? This question is best addressed by asking another question. Did the policy response to the first Covid-19 wave and the nationwide lockdown work?
Unfortunately, it is difficult to arrive at a definitive view on the latter. Those sympathetic to the establishment argue that had it not been for the second wave, the economy would have been in a much better shape. Those who disagree claim that even the sequential recovery which was achieved was profit-led and inequality-generating in nature.
This question can be approached in another way. What does a programme of credit guarantee for distress-ridden sectors seek to achieve? The short answer is that it offers a low cost option to a firm to prevent going bankrupt in the short-term. But it is also important to keep in mind the main reason for the distress — a harsh lockdown completely disrupting business, and deficient demand (which predates the pandemic). This means that unless there is a revival of demand, repeated credit guarantees to protect distress-ridden business is tantamount to kicking the can down the road.
The government, while choosing to offer credit guarantees rather than direct fiscal stimulus, is banking on recovery of demand by the time the loans have to be paid back (or written off). Is the government on the same page with private capital on this question? Results of listed firms do not suggest this (see https://bit.ly/3hkGV9D for details). While their profits surged, companies have used the money to deleverage (reduce debt) rather than undertake fresh investments. This implies that companies do not see the need to create more capacity to cater to what could be extra-demand in the future. The economic shock of the second wave, both for businesses and household finances, has made things worse on this front.
This approach to fiscal policy needs to be seen together with a pro-cyclical fiscal stance in the last fiscal year. Provisional data from the Controller General of Accounts (CGA) shows that Union’s gross tax revenue increased between 2019-20 and 2020-21, despite a contraction in nominal GDP. This otherwise impossible feat was achieved by a massive hike in union excise duties on petroleum products even as receipts from other tax heads fell. This has had a particularly regressive impact in an economy (see https://bit.ly/3Ac8ytM for details). Policies such as withholding dearness allowance payments to government employees have added to such pro-cyclical moves. As petrol-diesel prices hit new highs every day, inflation will generate further headwinds for incomes and demand, especially for those at the bottom of the pyramid.
The “tax petrol-diesel route” to fiscal prudence is also self-defeating in another way. It is a fact that fuel inflation has a cascading impact on business and household costs. With inflation inching up gradually, expectations of a roll back of the currently accommodative monetary policy (even though rates do not go up immediately) will gain further traction. Whether or not the current levels of low interest rates and liquidity signify the new normal in India is a question which needs to be debated seriously. The majority view is unlikely to endorse any such opinion. This makes the current monetary policy window more suitable to making windfall gains by deleveraging rather than accepting long-term commitments.
None of these arguments are new or difficult to grasp. And policymakers are acutely aware of these debates. Which warrants another question. Why is the government not convinced?
The only possible explanation is that the government may be scared of its own populism. Any large-scale fiscal relief such as a cash transfer programme or a pro-poor counter-cyclical intervention could be seen as potentially difficult to withdraw, especially in the run-up to the 2024 elections. Many economists see the delayed withdrawal of the fiscal stimulus after the 2008 crisis by the United Progressive Alliance (UPA) government as the major reason behind the macroeconomic crisis which followed in the second term of the UPA government.
Technocrats are perfectly justified in taking such a position. However, is this a politically tenable position?
There is enough research and anecdotal evidence to know that citizens, at large, are not engaged with questions such as fiscal deficit or current account deficit. In India, what they are most concerned about is inflation, perhaps even more than growth. Take an example: growth actually started going up towards of the end of the UPA-II period, but inflation that did not come down. The Congress paid heavily for this in the 2014 elections. To be fair, the inflationary spike under UPA was a result of sharp spike in crude oil prices.
The current government may think it is being prudent in not letting the fiscal situation go out of control by refusing to expand its fiscal stimulus, but it is actually actively fuelling inflation by refusing to cut taxes on petrol-diesel. This is risky from the political point of view.
The views expressed are personal
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