Will a stimulus package work in reviving India's economy?

When economy loses steam, it is tempting for any government to unleash a stimulus package to revive growth. But will it work, asks Sunitha Natti.

Steady growth and job creation is about surviving until the next century, but stimulus is about surviving until next election. That’s what Sir Humphrey Appleby of the classic political British sitcom ‘Yes Minister,’ in his inimitable style would have advised Prime Minister Narendra Modi if he were to book balance India’s finances. But, things have moved on that Sir Humphrey’s economic quackery embroidered with his ‘stop at nothing to maintain status quo’ logic would magically lift us out of our precarious ‘slow-growth, no-jobs, no-investment’ situation. 

No nation has ever spent itself into prosperity, but it’s the lack of private expenditure that’s bothering economists and policymakers right now. Fiscal stimulus to nail sluggish growth, a tool championed by select quarters, is bringing back the still unsettled debate on the dynamics of fiscal consolidation. 
If some favour government stimulus (`40,000- 80,000 crore) to revive growth, others explicitly argue that growth achieved through borrowed money isn’t desirable. Still others caution against a possible breach in fiscal deficit target (3 per cent for FY19).

Illustration: Amit Bandre
Illustration: Amit Bandre

Rating agencies are waiting in the wings to downgrade India’s sovereign rating to junk if the government fails to mind its deficit math. Should Finance Minister Arun Jaitley pursue fiscal consolidation, in other words, cut the debt-flab compromising growth? Or should one follow counter-cyclical measures like tax cuts and increase expenditure? Such a move could help the National Democratic Alliance (NDA) government win the electoral ballot in 2019. 

The stimulus verbiage also makes one believe it’s the genie in the bottle. But, historical evidence doesn’t decisively conclude that stimulus and increased expenditure actually works. A recent RBI study on public expenditure, too, confirmed that fiscal expansion in boom times is disastrous on all counts. It’s inconclusive that expenditure during recessions and when unemployment prevails is beneficial. 
Does it work? 

Opinion is divided on the most recent stimulus package announced in the aftermath of 2008 crisis. Between December 2008 and January 2009, excise duty was cut 4 per cent (6 for exporters), Plan expenditure was ramped up by `50,000 crore (Centre and state), interest subsidies rolled out for export-oriented industries. By one government estimate, these measures along with additional public expenditure during FY08 and FY09 Budgets, translated to 3 per cent GDP growth. 

But, others say stimulus was unwarranted given India’s strong macro-economic fundamentals. More than the need, delayed exit (stimulus withdrawal once the economy bounced back) did more damage. During the crisis period, the government and RBI continued highly expansionary policies to prop up the economy. Large public-sector pay increases, dole for MGNREGA, and a 4 per cent policy rate cut in seven months between September 2008 and March 2009. As inflation became sticky, RBI failed to reverse course quickly, taking a good three-and-a-half years to raise repo rate by 3 per cent. 

If you step back to the 1980s, the 1981 Budget raised taxes by 2 per cent to cut deficit even when the economy was in a recession. Some 350-odd economists, including Amartya Sen, opposed the move, but it trimmed inflation and bumped up market confidence.Likewise, when the alarming debt levels in early 2000s paved the way for a rule-based fiscal deficit framework -- FRBM -- in 2003, it plunged capital expenditure (not revenue expenditure) during the 2003-2007 boom period. The short-sighted approach reduced fiscal deficit alright, but the economy bore the brunt as GDP growth stagnated. 

India isn’t an isolated case with limited success to stimulus or expansionary expenditures. To the extent that what US does is viewed as a global benchmark, the message to fellow countries on stimulus is a sombre one. For, the two biggest stimulus programmes in the US history - - Hoover /FDR tandem in the 1930s and Bush/Obama pair in the last decade - - ended in the Great Depression and Great Recession, respectively. 

This is where the RBI study comes with an ice-breaking insight: The impact of a rise in government expenditure depends crucially on the prevailing macroeconomic conditions, especially whether there is full employment/unemployment and the complementary policies needed to generate finance. Also, for expenditure to have maximum impact on GDP, on household real income per capita and others, government consumption should be stepped up rather than pursuing additional transfers to households or imposing taxes. 

Typically, public expenditure grows faster than revenue leading to deficits and the constant struggle to keep it within limits. Between 1978 and 2018, every year expenditure and revenue receipts grew an average 6 and 4.6 per cent, respectively. Deficits must be eventually paid by running surpluses of by printing money, but it’s easier said than done.

Debt and its effects
Among all sources, Indian government borrows more from the domestic market, but an excess of it pushes up interest rates, making capital cost higher. For instance, in 1970-71, the prime lending rate nearly doubled from 9 to 17-19 per cent in 1994, resulting in fewer profitable investments, reducing investment demand. The aggregate rate of capital formation grew below potential at a mere 4.25 per cent in over two decades. Rising domestic borrowings also crowds out private investments, like it did post-2008 crisis. 

Governments also borrow from foreign sources, but could lead to a debt crisis, while dipping into forex reserves causes balance of payments (BoP) crisis as it did in 1991. Printing more money isn’t advisable as it stokes inflation. Usually, governments try a combination to prevent deficits going out of hand. 
Currently, our combined debt (Centre and states) at 64 per cent of GDP exceeds the FRBM’s mandated 60 per cent. Most of our debt is internal with a whopping 92.6 per cent coming from banks, insurance firms and PF as of March 2017. External debt, denominated in foreign currency, is within manageable limits with overseas investors accounting for just 4 per cent of government bonds.

Whether debt is internal of external, high borrowings implies fatter interest outgo. From 8.1 per cent in FY76, interest component in revenue expenditure, more than trebled to 24 per cent in over four decades ie FY18. Around 2000, when interest outgo touched a high of 30 per cent, it prompted fears that all the government earns may be paid as interest alone lending fears of a ‘debt-trap,’ which subsided soon. 

Traditionally, expenditure remained conservative till 1980s with central and state governments running revenue surpluses. Early 1980s saw limited reforms like trade liberalisation, export promotion and investment in modern technologies. But, growing deficits undercut social and capital expenditure. Capital disbursements were down 10 per cent between 1981 and 1991, as interest outgo nearly doubled. Within revenue expenditure, in 1970-71, defence expenditure led the pack with 34 per cent share, followed by interest component at 19 per cent and subsidies at 3 per cent.

By 1991, interest outgo had the highest share of 29 per cent, while subsidies and defence stood at 17 and 15 per cent, respectively. 
The 1991 expenditure strategy followed by FRBM implementation in 2003, reduced subsidies and non-capital expenditure. But, given the huge debt, interest payments continued to peak touching 36 per cent (of revenue expenditure) in 1995-96. Conscious efforts like debt-swap scheme and debt consolidation and relief facility lowered the ratio of interest payments to revenue receipts to below 15 per cent – the level prescribed by the 12th Finance Commission in early 2000s. However, the 2003-07 boom period saw high debt and deficit. Ironically, little changed with interest payments maintaining the lion’s share of 28.5 per cent in FY18 (BE), followed by subsidies at 15 per cent and defence at 9.6 per cent.  

Historically, our development strategy followed a conservative fiscal policy, where deficits were kept under check. But growth was anaemic; so, the 1980s saw tax reforms to increase share of direct taxes and bring deficit under control. In 1970-71, of the total revenue, direct taxes contributed 16 per cent, indirect taxes 58 per cent and the remaining 26 per cent was from non-plan revenue. In 1973-74, there were 11 income tax rates with the highest slab of 97.5 per cent. Now, it’s down to 3 slabs -- 10, 20 and 30 per cent. Similarly, the basic corporate tax rate, which varied between 45 and 65 per cent during the 1970s, now hovers at 30 per cent.

SLIPPING ON  STIMULUS

As the government is reportedly considering a stimulus package to revive the economy, Swiss brokerage UBS has estimated a slippage of 0.5 per cent on the 3.2 per cent fiscal deficit target for the current year. “We believe the Centre will likely breach the FY18 fiscal deficit target of 3.2 per cent of GDP by 0.5 per cent if it goes about with a fiscal stimulus package,” analysts at UBS Securities said in a note. “The government is contemplating deviating from budget targets, which could result in fiscal slippages,” the note said.

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