Demand thrust must be at heart of next stimulus

The government’s second stimulus aimed at boosting consumption has been touted as insufficient. Experts argue that the Centre needs to expand its expenditure, so as to cushion demand in the economy, rather than focusing solely on supply. Mint takes a deep dive.

What is India’s current economic situation?

The pandemic’s impact on the economy could be clubbed into three categories—the lockdown phase, normalization phase, and recovery phase. At present, the Indian economy is under the normalization phase. That is, economic activity is gradually going back to pre-covid levels. The process of normalization has been slow as there is still risk aversion due to the pandemic and there have been nominal wage cuts across sectors. The loss of economic activity for a major part of the financial year and the consequent balance sheet contraction are also responsible for the slow pace of normalization.

How did the previous two packages fare?

The focus of the first package was to address the cash-flow mismatch for firms as their fixed expenses continued despite little to no activity amid lockdowns. The aim was to prevent bankruptcies and shutdown of companies. It was complemented with cash transfers and higher outlay in rural sector which resulted in agriculture growing at 3.4% in Q1FY21 as against 3% in Q1FY20. The second package aimed to drive private consumption, primarily by granting incentives to government employees along with committing to existing expenditures. The Centre also encouraged states to ramp up infrastructure spending.

How do demand and supply side interventions differ?

Many have termed the bulk of response by the Centre as supply side interventions and argued for a more direct demand-led stimulus. Cash transfers would be deemed as demand interventions, while reforms along with credit-support measures could be viewed as supply interventions. Supply boost, however, does have second order impact on aggregate demand.

Are there any major constraints to revival?

The Indian economy has been underperforming since the second quarter of 2018, before covid-19 struck. Thus, the key toward an accelerated recovery would be to identify some other constraints to growth that were prevalent before. These constraints are specific to different industries. For instance, restoring the health of financial sector, primarily banks and NBFCs, will be critical. More so given the prospects of higher bad loans due to the pandemic. Real estate and automobile sectors may also need some policy support.

Is there any case for a fresh stimulus?

While many argue that there is still a case for fresh stimulus, however, the pace of normalization does indicate the effect of previous interventions. By committing to its budgeted expenditure, Centre will see a substantial increase in its deficit, even without increasing expenditure further. This will be due to less revenue mobilization from taxes or divestment proceeds. We should see some results over the coming quarters. However, a third stimulus, this year or in the next budget, cannot be ruled out.

Karan Bhasin is a policy researcher.