India’s GDP growth in the April-July quarter slumped to 5.7%.
Demands for unleashing a fiscal stimulus have grown stronger.
What is it?
A ‘stimulus’ is an attempt by policymakers to kickstart a sluggish economy through a package of measures.
A monetary stimulus will see the central bank expanding money supply or reducing interest rates to encourage consumer spending.
A fiscal stimulus is one in which the government spends more from its own pocket or slashes tax rates.
Stimuli puts more money in the hands of consumers and spending goes up – thereby encouraging demand & growth.
What is the logic behind?
Concept - Proponents of fiscal stimulus, base their arguments on the Keynesian theory of macro economics.
Keynes argued that even small direct interventions by the Government to prop up demand, can have a disproportionately high impact on economic growth due to the multiplier effect.
The explanation - When demand in an economy stays weak for long, businesses stop investing in new projects, unemployment rises, income shrinks and consumer confidence wanes.
This further hinders spending due to lack of money and thereby dampens demand – creating a vicious cycle.
If the Government can step in with a fiscal stimulus, it revives business confidence, restarts projects, creates jobs and sets off a virtuous cycle of feel-good, demand and growth.
What was our previous experience?
The 2008 Sub-prime crisis saw countries like US, Europe, Japan and China rolling out large fiscal stimulus packages.
India’s too gave out a package then included export subsidies, excise duty cuts and Rs.10,000 crores for infrastructure financing.
The government employees were also given a pay revision & a large order for new buses to replace public transport fleets was made.
As a consequence GDP growth revived from 6.7% in FY09 to 8.6% in FY10 and to 8.9% in FY11.
But at the same time, fiscal deficit of the government for FY09 rose to nearly 8% of GDP, from the projected 2.5%.
Subsequently, when the stimulus was rolled back, growth promptly slumped.
What are the concerns now?
The government currently faces a situation very much similar to the one in 2008.
While generous public spending may boost investments & demand, the government will loose out on its fiscal deficit target that is currently pegged at 3.2 %.
This may not go down well with foreign investor sentiments.
Whether the economy will take off on its own once the stimulus wears off is also doubtful.
How does the future look?
If the government decides to go with the stimulus it would have to identify its priorities clearly.
Duty cuts on petrol, constructing of affordable homes, banks recapitalisation & cheaper lending to MSMEs are some options.
While a stimulus will rejuvenate the economy through budgetary spending, the government would have to eventually earn it back.
Hence, tax revenues through other means will ultimately pinch the citizens after a while.
