Financing of the Covid-19 economic package – analysis
The wait is over. He arrived in Prime Minister Narendra Modi’s fifth speech to the nation in two months. The end of his speech, which incorporated everything from Bharatiya. sanskriti (culture) to solar energy, it went off like a bomb. Just when most observers of government actions since the coronavirus pandemic had more or less resigned when announcing an economic package, a much larger than expected one was announced.
During the silence of the central government, some well-designed packages were proposed from abroad. One of the opposition had proposed a package of more than Rs 5 lakh crore. This focused on relief. While relief is vital and is expected of a government that implemented a blockade without debate, it cannot address the subsequent recovery in the economy. An industry package that represented broader concerns and increased weight, amounting to £ 15 lakh crore. At Rs 20 lakh crore, the package announced by the prime minister beats even the last.
Coincidentally, it exactly matches the recommended amount in a proposal made in an article on these pages on April 15. One difference is that while the latter had proposed a pure fiscal stimulus of Rs 20 lakh crore, the Prime Minister’s package includes the financial implications of measures taken by the Reserve Bank of India (RBI) so far and some relief offered in March. It is, therefore, a measure of the combined response of monetary and fiscal policy to the demands of the moment. However, even if the monetary measures are taken to the tune of more than Rs 4 lakh crore, the package is really great.
At around 10% of GDP, the stimulus is only slightly lower than that announced in the United States. The political element in the magnitude of the response cannot be overlooked. The announcement came at a time when infection cases in India are not only on the rise, but rising rapidly despite the fact that the world’s strictest blockade, with associated difficulties, has been in place for seven weeks. The economy could no longer be ignored.
While the content of the package will emerge slowly, the prime minister’s speech suggests that it is comprehensive and encompasses most sectors of the economy. However, aside from the possibility that political considerations may end up extending the outlay, there remains a technical problem.
Of the four focus areas mentioned, liquidity is one; land, work and laws are the others. Now, while RBI’s improvement in liquidity is important, global experience points to its weakness as a method of reviving a crisis economy. A central bank can improve banks’ capacity through repos, but cannot compel them to lend. Judging by the volume of funds that the latter have stationed with RBI, it can be concluded that they are reluctant to do so, so it is the right time to contemplate negative interests in these holdings. The point is that the higher the proportion of measures to improve liquidity in this economic package, the less powerful it will be.
Having recognized the boldness of the announcement, we would be interested to know how the additional outlay will be financed. For the time being, the government should seriously consider the route of financing the money, since financing the deficit will raise interest rates. A mixed objection is that the first is inevitably inflationary. In reality, it is nothing more than a monetary relief implemented by the central bank.
For almost six decades, after RBI was founded, monetary financing was routine. In the mid-1950s, there was much doubt that the second five-year plan was deficit-financed. There was some inflation, but in seven years after the plan was launched, the economy had slowed down the colonial growth rate that had prevailed for half a century. By the time monetary financing of the central government deficit was suspended in the 1990s, growth had accelerated twice more. In reality, a period of high inflation came after 2008, long after monetary financing was suspended.
But recognizing the possibility of inflation, the largest spending now planned can be spent in tranches, holding back spending if there is a sudden increase in inflation. In addition to inflation, some Indian economists residing abroad have warned of capital flight if the fiscal deficit increases. India’s foreign exchange reserves currently exceed portfolio investment volume. Anyway, why would foreign institutional investors want to flee India exactly when, with the newly announced economic package, there is a chance of becoming the world’s fastest growing large economy?
With the technicalities over, the irony of a government that has distanced itself from almost every aspect of the economic policy of early independent India that now adopts its premise is evident.
Self-reliance was the motive for the policies applied in India in the 1950s, and the country rapidly industrialized. In the next decade the Green Revolution came, which freed the nation from food imports. In contrast, the 2014 “Make in India” initiative has been less disruptive. That the newly minted “Atma Nirbhar Abhiyaan” succeed.
Pulapre Balakrishnan is Professor at Ashoka University, Sonipat and Senior Fellow, IIM Kozhikode
The opinions expressed are personal.