We need immediate stimulus of around 5% of GDP: Rakesh Mohan3 min read . Updated: 01 May 2020, 12:28 AM IST
- Former RBI deputy governor Rakesh Mohan said India has the capacity to sustain high temporary fiscal deficits and then recover by restoring relatively healthy economic growth
- The longer we delay the rollout of the fiscal relief programme, the larger will be the need, says Mohan
India needs an immediate fiscal stimulus of around 5% of gross domestic product (GDP) and the needs will increase the longer the government waits to announce such a measure, said Rakesh Mohan, who for the most part of his career has been in the policy hot seat, first as an economic adviser during the 1991 balance-of-payment crisis, which triggered a big burst of reforms, and later as a central bank deputy governor.
Mohan, who is now a senior fellow at the Jackson Institute for Global Affairs at Yale University, said in an interview that India has the capacity to sustain high temporary fiscal deficits and then recover by restoring relatively healthy economic growth. Edited excerpts:
We do need to act quickly to safeguard livelihoods, help economic activity and businesses of all sizes to weather the downturn, and maintain access to essential public services. As we all know, large segments of the Indian population make their living in informal jobs, which means that they live from day-to-day dependent on their daily earnings. So, I would imagine that effective unemployment in urban India must be much higher because of the lockdown than it is in the US. Furthermore, most of our labour lack any kind of a safety net to even survive temporary disruptions of livelihoods as is happening. So, the loss of employment and earnings will need to be compensated by the government.
Need for a stimulus
I feel that we have a narrow window to enact fiscal relief measures that are designed to limit the pain now, and which help to shorten the duration of the economic crisis, and to reduce the possibility of the need to take greater fiscal measures later.
Relief vs stimulus
This time around, the fiscal expenditures would be much more in the nature of fiscal relief rather than stimulus. So it can be done much more safely, as long as India returns to prudence after covid-19. This is the important point: fiscal relief expenditures must be seen as substitutes to private expenditure, which is currently constrained because of the lockdown and will continue to be restrained even as the lockdown is lifted on a gradual basis.
Experience suggests that India has the potential capacity for sustaining high temporary fiscal deficits and then recovering by restoring relatively healthy economic growth. It is also true that the excess fiscal and monetary stimuli in 2008 and beyond did result in both continuing high fiscal deficits and a spike in inflation to around 2013. But that was in different circumstances when the high fiscal expenditures and tax cuts did constitute a significant fiscal stimulus.
Size of fiscal relief
Calculations suggest that we need an (additional) fiscal programme of around 5% of gross domestic product. The longer we delay the announcement and rollout of the programme, the larger will be the need. So, time is of the essence.
There are a number of sectors, such as hotels and airlines, logistics, auto industry, construction and textiles, which are suffering 50% or more erosion in earnings and output. Unless fiscal help is given to these sectors in an organized and timely manner, there could be permanent damage. We could also be looking at the emergence of very large NPAs (non-performing assets). This has to be avoided.
I would suggest one measure. Even if we reduce the policy rates to below the current level, the likelihood of lending rates going below the current levels is very low. That is what we also saw in 2008-09. So the government should contemplate across the board interest-rate subsidy of 2-3% for on-lending by banks, and possibly NBFCs for a specified time. The cost of this is quite low in current circumstances; additional lending of ₹1 trillion will mean a fiscal cost of only ₹2,000 crore. What this does is to keep deposit interest rates at reasonable real rates, borrowers get the benefit of low interest rates, while protecting financial stability of the system.