What should the government focus on first: increasing demand or streamlining the supply side. This question is at the heart of the debate that has been going on after the government announced the stimulus package. This article argues on two lines- Inadequate size of the package and the neglect of the demand side in the package.

Why stakeholders are not happy with the package?

• Agriculture sector: There is relief for agriculture in the form of a concessional credit line of Rs 2 trillion, but loans are neither automatic or assured.
•  Marketing reforms and infrastructure creation are distant promises.
• MSME sector:  The backbone of the economy that provides 25 per cent of employment, 32 per cent of the GDP and 45 per cent of exports, is unhappy despite the Rs 3 trillion line of credit for loans without collateral.
• In their experience, lenders are not always supportive in extending loans.
• While buyers-central and state governments, public sector firms and the private sector- owe them as much as Rs 5 trillion.
• What is more, most MSMEs just do not have the resources to pay wages or meet fixed costs on electricity, rent or interest during the lockdown period.
• Corporate sector: There is nothing for the corporate sector in manufacturing or services.
• The distressed sectors such as airlines, automobiles, hotels, restaurants, and tourism have been ignored.
• Ironically, there is little for public health, already in a dilapidated state.
• Even stock markets, characterised by irrational exuberance in the past month, have dropped.

Government expenditure in the fiscal stimulus

• The fiscal stimulus, which can be defined as government expenditure that could stimulate demand, is difficult to separate.
• This is because the package is neither clear nor transparent about the cost to be borne by the government in each component.
• Even so, there are 12 estimates by analysts in financial sector institutions, suggesting that the fiscal stimulus is in the range of 0.7 per cent to 1.3 per cent of the GDP.
• The effective fiscal stimulus, in terms of extra resources provided by the government, is Rs 1.76 trillion, or 0.8 per cent of the GDP.
• Its contribution to domestic demand will be minuscule, given that private final consumer expenditure in India is about 60 per cent of the GDP.

Focus of the package: supply side

• It is clear that the design of this relief package seeks to focus on the supply side.
• Package emphasises on providing liquidity through lines of credit, where the RBI is providing as much as Rs 8 trillion.
• Focus is not on the demand side by stepping up government expenditure.
• This is done with the aim of minimising the cost to the government.
• The arithmetic is obviously imaginative — as much as Rs 10 trillion of the relief package will have to be financed by sources other than the Centre and the RBI.

So, let’s understand why focus on supply side is flawed strategy

• This stress on the supply-side, while neglecting the demand-side, reveals a flawed understanding of economies in crisis.
• Speed of adjustment: Even in normal circumstances, the speed of adjustment of the supply-side is slow because supply responses take time.
• Whereas the speed of adjustment on the demand-side is fast as incomes spent raise consumption demand without any time-lag.
• At present, if there is little or no increase in demand, supply responses will be slower than usual because producers would not wish to pile up inventories of unsold goods.
• In terms of the chicken-and-egg parable, demand must be revived first to kickstart the economy.
• For this reason, the fiscal stimulus should have been much larger.

Excessive concerns over fiscal deficit

• The decision-makers have been timid, intimidated by the prospect that, because of revenue shortfalls (2 per cent of the GDP or more), the fiscal deficit would be 5.5 per cent of the GDP.
• Which would have exceeded the budget estimate at 3.5 per cent of the GDP.
• The conclusion drawn, wrongly, is that there is no fiscal space.
• The obsessive concern about the fiscal deficit is deeply embedded in government thinking.
• In this situation, the extra fiscal stimulus should have been Rs 7-9 trillion i.e. 3-4 per cent of the GDP and that would have been modest compared to what other countries have done.

Monetising the deficit  and issues involved in doing so

• This enlarged fiscal deficit (3-4 % of GDP) cannot be financed by market borrowing.
• Such market borrowing would simply drive up interest rates and nip recovery in the bud.
• It would have to be financed by monetising the deficit — RBI buying government T-bills — printing money, now termed “helicopter money”.
• Inflation concerns: The idea that monetised deficits will unleash inflation is blind to the reality that, at this juncture, if there is no further intervention by the government, the GDP could contract by 5 per cent in 2020-21, with lingering consequences.
• In fact, a monetised deficit might be the only way of increasing aggregate demand to revive economic growth.
• Rating downgrade issue: The worry about a downgrade from credit rating agencies is bizarre.
• For one, their ethics and integrity have seen steady erosion.
• Moreover, how many sovereign governments will they downgrade?
• In fact, we might be better off without the footloose and volatile portfolio investment inflows.

Consider the question- “Do you agree with the view that the focus of the supply side should be at the heart of any stimulus package announced in the financial crisis? Give reasons in the support of your agreement.”

Conclusion

If the government does not accept the necessity or wisdom of expansionary macroeconomic policies, it must set out its alternative plan for recovery. The relief package will not suffice.

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