The article discusses the fiscal response of the government to deal with the corona crisis. Fiscal response to the 2008 financial crisis was higher in terms of GDP percentage. Also, a comparison with emerging peer economic indicates that India might be running the tighter fiscal policy in the time of crisis. The article suggests higher spending by going beyond the traditional fiscal space.

A possible explanation for moderate fiscal response by the government

• The Indian government has till now come up with an insipid fiscal response to the ongoing economic crisis.
• Long battle: One view is that the government does not want to fire all its bullets in what threatens to be a long battle. It wants to time its interventions.
• Weak public finances: The other possible explanation for this fiscal timidity is that India has entered this crisis with weak public finances.

Comparison with finances at the 2008 financial crisis

• The combined official fiscal deficit of the Union plus state governments was at its lowest level in many decades.
• The economic boom of the preceding four years had led to higher tax collections pouring into the treasury.
• The massive increase in spending announced in the budget of February 2008 was with an eye on the national election scheduled a year later, rather than in anticipation of a coming storm.
• Then followed the second wave of fiscal expansion after the North Atlantic financial crisis hit Indian shores seven months later.
• Back then, India’s effective fiscal stimulus over two years was a substantial 4.3% of gross domestic product (GDP).
• In 2020, the crisis-driven spending plan announced by the government so far is less than 1% of GDP.
• There could yet be a big fiscal push in the coming days.

Tighter fiscal policy in crisis compared to other emerging economies

• Some of the budget estimates released a few days ago by the International Monetary Fund are telling.
• In 2018, the total fiscal deficit of the Indian government as a proportion of GDP was 2.4 percentage points higher than the average for Asian emerging markets.
• India is expected to end 2020 with a total fiscal deficit that will be 2.5 percentage points lower than Asia’s average.
• In other words, India ran a looser fiscal policy compared to the rest of Asia in normal times, but is likely to run a tighter fiscal policy than its regional peers in a crisis year.
• Something similar can be seen in estimates for public debt.
• Asian public debt as a proportion of GDP is expected to go up by nine percentage points in 2020.
• The comparable figure for India is 2.9 percentage points. (These estimates are being cited with full knowledge that forecasting models break down during extreme events.)

Funding extra expenditure through money creation

• Lack of traditional fiscal space should not hold the government back in a crisis situation.
• There are many options outside the consensus macro playbook.
• Money creation: A commonly cited option right now is funding extra expenditure through money creation rather than borrowing.
• The size of the Reserve Bank of India (RBI) balance sheet as a percentage of nominal GDP is close to its 35-year average.
• There is scope for printing more money right now.
• Lower inflationary pressure: And the inflationary consequences are likely to be muted because of the lower velocity of money amid a demand collapse.
• Public finances in the future: Getting public finances back on track is a battle that lies in the future.
• A rapid recovery in economic activity would be the best solution.
• Otherwise, history tells us that countries have brought down their public debt numbers through some combination of financial repression, austerity, higher taxes and inflation.
• Some element of capital controls could also be back in play.

Need for increasing discretionary government spending

• The collapse in tax revenues as the economy is shut down will automatically lead to a rise in India’s fiscal deficit.
• However, there is a need for an increase in discretionary government spending as well.
• Economists have shown that spending multipliers are higher than tax multipliers in India.
• In other words, the increase in economic output for every unit increase in the fiscal deficit is higher when the government spends rather than changes tax rates.
• State’s spending Vs. Union spending: Spending by states gives more bang for the buck than equivalent spending by the Union government.

“Below the line measures” to support the economy

• Also, there are options other than direct spending to support the economy.
• Countries such as Germany, the UK, Italy, France and South Korea have complemented traditional fiscal expansions with “below the line” measures such as loans and guarantees to companies.
• In an excellent recent study, analysts estimate that more than half of Indian corporate balances sheets will be unable to meet expenses with zero revenues.
• They are careful to point out that their analysis is based on extreme assumptions that there is no fall in their wage bills, no revenues, and no access to fresh credit.

One of the common suggestions we have been coming across is the spending by the government by printing money. In this article, the second important suggestion is below the line measures. Take note of these measures and options available with the government.

Way forward

• The poor need income support for their very survival. That should be at the top of any democratic government’s list of
• However, protecting Indian companies from a financial collapse also matters, because otherwise, the economy will see a reduction in its capital stock, which will be needed both for a rapid recovery as well as job creation once the worst is over.
• There are contagion risks in financial markets as well, going by what has happened to some mutual funds that were invested in bonds.

Conclusion

These are extraordinary times that require extraordinary measures. The danger from a delayed fiscal programme is that hysteresis may set in, as companies run out of money and supply chains are broken, damaging our economic prospects in the medium term.

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