All over the world, governments are looking to spend their way out of trouble. Side by side with the attempts to shore up the tottering financial system, policymakers from China, South Korea and Taiwan in Asia, Russia, Australia and several countries in Europe have all announced fiscal stimulus packages.
On Monday, the UK government announced its biggest stimulus plan in two decades, and a new Europe-wide package is likely on Wednesday. In the US, the President-elect has said that he would spend as much as needed, with some estimating that the plan would involve spending of up to $700 billion (Rs35 trillion). Governments are now bringing out their biggest guns in their fight against global recession.
Most discussions in India, however, have acknowledged that the scope for priming the fiscal pump is very limited, thanks to Union government profligacy. A new twist has been added by the government’s recent claim that it saw the slowdown coming, which is why it went in for income boosting measures such as the pay hikes for the public sector and the debt waiver for farmers.
Also See Headroom?
A look at the combined fiscal deficits of the Union government and the states shows that there has been a significant reduction in these deficits as a percentage of GDP (gross domestic product) in recent years. For instance, the combined deficit of the Centre and the states was as high as 9.94% of GDP in 2001-02 during the last downturn, and this went down to 5.56% in 2006-07. The 2007-08 revised estimates put the combined deficit at 5.26% of GDP, while the budgeted estimate for 2008-09 was a much lower 4.61%.
But if you include oil bonds, fertilizer bonds, the debt waiver and the pay hikes, the combined deficit will be as high as 8.5% of GDP. Nevertheless, that’s still lower than the deficits in the early years of the decade, which would have gone up even more had below-the-line items been added.
In the circumstances, economists have started asking the question whether, in addition to the monetary policies taken, counter-cyclical fiscal policies are also called for. True, the combined total liabilities of the Union government and the states are a high 80% or so. But Indranil Pan, chief economist with Kotak Mahindra Bank Ltd, points out that this ratio is even higher for Japan. With interest rates coming down, the cost of servicing the debt will reduce.
“There has been significant fiscal consolidation in recent years,” says Gaurav Kapur, senior economist with ABN Amro Bank, “and we can afford to increase the deficit, provided it’s clear that the rise will be temporary.” He points out that under the current circumstances, there is little chance of public borrowing crowding out private investment.
Ajit Ranade, chief economist of the Aditya Birla Group, argues that the fiscal deficit should be monitored over the entire business cycle, rather than on a year-to-year basis.
Ranade also says that, compared with the early 2000s, India’s savings rate is now much higher, which means that domestic financing capacity is also higher. According to Ranade, there’s enough headroom for a fiscal push. As the slowdown deepens, expect the clamour for a relaxation of fiscal policy to get shriller.
But there may be a big catch holding up any attempt at pump-priming, even if the government wants to do so. That is the proximity of the elections. Once the election dates are announced, only a vote on account to run the government machinery can be taken and any fiscal boost will have to wait. Pan estimates that the earliest fiscal push can come only at the end of August next year.
But even if India can’t join the party, will a coordinated global fiscal stimulus yield results? Well, between 1929 and 1932, the US economy shrank by 27%, according to data compiled by economist Angus Maddison. Between 1933, when the US New Deal started, and 1937, the economy expanded by 38%. And though the US economy contracted again in 1938, it bounced back in 1939. Economists disagree whether it was the New Deal or World War II that pulled the US economy out of the Great Depression. But the GDP numbers tell the story.
Fiscal expansion is, however, no silver bullet. Japan tried fiscal pump-priming several times in the 1990s, without much success. As economist Milton Friedman put it succinctly, “Does fiscal stimulus stimulate? Japan’s experience in the 1990s is dramatic evidence to the contrary. Japan resorted repeatedly to large doses of fiscal stimulus in the form of extra government spending… The result: stagnation at best, depression at worst, for most of the past decade.”
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