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Photo: Mint

Opinion | The unpleasant arithmetic behind India’s relief package

A close look at India’s financial relief package raises questions over the true size of the stimulus and the potential effectiveness of the measures announced by the government

The apocalyptical drop in April’s Purchasing Managers’ Index and the staggering 16.5% drop in March industrial production when only one week was under lockdown should be ominous indicators of the unprecedented scale of economic damage India might face. Quarantine measures are being eased, but the lockdown in the “red zones", which account for a large part of India’s gross domestic product (GDP), could well be extended as the covid infection rate has shown no discernible sign of peaking.

Against such a portentous backdrop, it is easy to understand the clamour for policy support and the reason why the government announced this week a 10%-of-GDP relief package. Before one starts unpacking the details, it might be instructive to compare the size to what other countries have announced. And not to the US or Europe, but to India’s peers. For example, taking together central bank and government support, as has been bundled in India’s package, Brazil so far has announced support of 20% of GDP. Despite this much larger support, this year GDP in Brazil is expected to decline 7% and the fiscal deficit widen to 15% of GDP from 6% in 2019.

So, is the 10%-of-GDP support adequate? It depends on the depth of the collapse in growth and the pace of the recovery, which we will only know over time. However, what we do know from previous such crises is that the single-biggest factor that undermines a recovery is the damage to households’ and firms’ balance sheets. The larger the damage, the longer and slower the recovery. Thus, relief packages need to focus almost exclusively on ensuring that such damage is minimized. This means providing direct cash support now and not promises of support at some uncertain time in the future.

So, did the relief package do that? From what has been announced and what one can infer, the bulk of the support is in the form of liquidity already injected by the Reserve Bank of India (RBI) into banks, and credit guarantees for bank lending to small and medium enterprises (SMEs). This is somewhat ironic. Despite the cheap liquidity provided by RBI, banks have refused to take on the credit risk and lend to SMEs. Now the government has been pushed to provide credit guarantees to nudge the same banks to lend. Taking these, and similarly-aimed programmes, the total support amounts to 4.2-5.7% of GDP.

But several things have to fall in place if these schemes are to be effective. The cash injection, including a “special liquidity scheme" that would purchase non-bank financial companies’ debt, the expansion of the rural unemployment guarantee scheme, and direct cash transfers via Jan Dhan and Mudra accounts, etc., amount to just about 0.8-1% of GDP.

This is consistent with the earlier announcement that the Central government will borrow an additional 2% of GDP this year. If this is the line on the sand (of course, the government can change its mind later), then the potential revenue shortfall and cash relief measures (including those that might be announced later) must add up to 2% of GDP. Otherwise, planned spending will need to be reduced. Put differently, given the covid-related cash outlay of 1% of GDP, any revenue shortfall of more than 1% of GDP will require budgeted spending to be cut. If the shortfall is more than 2% of GDP, then even total spending will need to be cut. This is the unpleasant arithmetic of the relief package. To provide some context, in Brazil and South Africa, which had similar-sized deficits in 2019 (compared to India’s Central and state budgets taken together), the deficits for 2020 are expected to more than double to around 15% of GDP on just revenue shortfalls, with all relief spending offset by cuts elsewhere.

In the light of India’s limited fiscal space, one understands the need to minimize the cash outflow and push much of the relief package onto future liabilities and RBI liquidity provisions. But the latter has a far less chance of being effective than the former. Did it have to be this way? A simpler solution was to take the entire tax shortfall as a revenue loss and focus on income support as determined by the size of the economic shock. This support could have been provided via Jan Dhan and Mudra accounts to households and SMEs whose incomes do not fall under any tax bracket and through tax credits for 2019-20 obligations to those who do have tax liabilities. The income support would then need to be offset by cutting budgeted spending, including on infrastructure. Reasonable estimates suggest that the total public sector deficit would then rise by 4 percentage points, which could be financed by RBI bond purchases. In addition, and taking a leaf out of the US Federal Reserve and European Central Bank playbooks, RBI could provide liquidity directly to corporates, instead of through banks supported by government guarantees, as proposed now.

Eyebrows are likely to be raised at such a proposal. But the need of the hour is income support, not more spending. And in India, as elsewhere, the central bank is now the only entity that has a strong enough balance sheet to provide that support. This is an unprecedented shock. It calls for unprecedented responses. The crisis has not been caused by bad economic policies, but a weak and ill-conceived policy response could worsen it.

Jahangir Aziz is chief emerging markets economist, J.P. Morgan. These are the author’s personal views

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