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In Search of a Real Stimulus

11 December, 2008, Jayati Ghosh

Now that the economic slowdown is clearly making itself felt in both economic activity and employment, the central government has finally decided to do something about it. The trouble is that the economic package announced on Sunday is simply too feeble to go very far and, even combined with the monetary policy measures announced earlier, is unlikely to reverse the overall decelerating tendency. 

Thus far the government had focussed on the financial side of the current crisis. There were measures to infuse liquidity into a banking system that had become very constrained by reducing the Cash Reserve Ratio and the Statutory Liquidity Ratio, to reduce interest rates by bringing down repo and reverse repo rates, and to provide some relief to non-bank financial institutions, particularly insurance companies. These were confidence-building measures that were apparently necessary because (despite official claims to the contrary) the Indian banking system had in a less severe form, several of the fragilities that undermined the US banks. 

But the monetary measures that were supposed to deal with the credit crunch all proved to be lacking because they did not accept the need to deal with the liquidity trap characteristics of the current economic situation. Banks are unwilling to lend to any but the most credit-worthy potential borrowers, but such potential borrowers are unwilling to borrow because of the prevailing uncertainties and expectation of slowdown. Meanwhile, all other enterprises, even those who desperately require working capital just to stay afloat, find it increasingly difficult to access bank credit even as they face more stringent demand conditions. 

In such a situation, reducing interest rates does not solve the basic problem of tightened credit provision, even though it may marginally reduce costs for those who are able to access bank credit. Some of the measures seemed to be more designed to push up the stock market than to revive the real economy. But already, in addition to the credit crunch, the slowdown has led to very rapid deterioration in market conditions facing many producers: for example, exporters, especially small-scale producers; the construction industry, which is a very large employer; most of all, agriculturalists producing cash crops whose prices have collapsed. 

So it has been clear for some time that a fiscal stimulus is essential, and it was almost a mystery why the government took so long to announce one. Indeed, the rather pathetic attempts of the Prime Minister and ex-Finance Minister to declare that they had anticipated the global downturn by including a large fiscal deficit in the annual budget (when in fact it was no more than the result of some pre-election sops offered out of political exigency) even led some to suspect that no new fiscal package would be forthcoming. Of course, this would be absurd – but then, the straitjacket of neoliberal economic thinking has created even greater absurdities in the past. 

Anyway, the central government did finally announce a fiscal package, which was by then much-awaited. But unfortunately the promised fiscal expansion is a rather small one – only up to Rs. 20,000 crore of direct additional spending through the Planning Commission in unspecified areas. This is less than 0.5 per cent of GDP, a tiny fiscal input which is too small to be really countercyclical or even to change the expectations of private agents in any meaningful way. 

This direct spending is combined with a tax cut measure, on domestic duties – the ad valorem Cenvat rate is to be reduced by 4 percentage points. This will have an impact in terms of supporting economic activity only if producers respond by cutting prices, and such price cuts generate demand responses. But neither is inevitable. For example, the recent cut in the price of aviation fuel was not passed on to consumers by the airline companies, and even now only one carrier has promised to reduce the aviation fuel surcharge. So that particular measure simply became an additional subsidy to shore up profits of airline companies.

It is not clear whether this Cenvat reduction will meet the same fate, reducing government revenues without generating more economic activity. But certainly it is true that in times of economic uncertainty, tax cuts are much less effective in stimulating activity than direct government expenditure. 

The other measures are really rather modest in scope and niggardly in content. The only substantial measure directed to highly employment-intensive units in exporting sectors like textiles, garments and leather is a small reduction in the interest rate on export credit. In addition, there are some small tax concessions and a tiny (Rs. 350 crore) addition to export incentive schemes. These are hardly likely to counteract the effect of big losses of export orders as the major markets start shrinking. What was required was a more serious and systematic attempt to allow these industries to keep producing at technologically efficient levels and shift demand to other markets.

The mention of expanding the Indira Awas Yojana is surely welcome – but note that the money for it is supposed to come out of the Rs. 20,000 crore package rather than being additional to it. The measures to provide more finance and loan concessions for small borrowers of home loans are also welcome. Refinancing of small, medium and micro enterprises is important, but how well the new mechanism will actually function is not clear, and the amount announced (Rs. 7,000 crore) is relatively small. 

Some of the proposed measures make very little sense – for example the elimination of export duty on iron ore fines and reduction of export tax on iron ore. There is really no reason why India should want to incentivise the export of iron ore, rather than encourage the domestic processing of it into steel. 

But what is even more significant is what the stimulus package leaves out. It is not just that the overall size of the package is too small to have much of an effect. It is also that some of the most critical areas of spending have been neglected. 

State governments have already started feeling the resource constraint as their tax revenues are affected by the economic downturn, and they are responsible for most of the public services that directly affect people, such as those relating to agriculture and rural development, health, sanitation, education and so on. Yet there is nothing proposed to alleviate the fiscal crunch of state governments, who face a hard budget constraint. So the overall conditions of life of the citizenry are likely to be affected. Yet the Centre could so easily have announced some measures to provide fiscal relief to the States to help them cope with the adverse effects of the downturn. Such measures could include reducing interest rates, providing more central funds and most of all relaxing fiscal responsibility norms that are inappropriate for the current situation and which the Centre itself has already discarded. 

Similarly, the food crisis has been forgotten in all the excitement about the financial crisis, but food insecurity remains widespread and may even be spreading, given the significant rise in prices over the past two years. While overall inflation has been easing, food inflation in India continues despite large food grain stocks. And the real incomes of workers and cash crop cultivators have not kept pace with this. Poor or inadequate nutrition is already a big problem, which will deteriorate as the downturn worsens. This is a time to allocate much more money on expanding, universalising and improving the functioning of the Public Distribution System. This would at least partly alleviate the problems of those who are already at the margin of survival, as well as those who could be tipped over into poverty by recent economic processes. Yet there is no mention of any such attempt in the package, or of any actions to address the problems of cultivators. 

So this is a partial, half-hearted and essentially unconvincing attempt to deal with an economic situation that is likely to worsen in the near future. This may be because the central government itself is not fully convinced of the need for clear Keynesian measures, or does not even understand what these should consist of. It is hard to see what else is preventing the government from acting more decisively.



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