India needs a strong fiscal stimulus
India has seen among the most stringent prevention responses to the coronavirus disease (Covid-19) so far. With a complete lockdown for three weeks already, and a further 19 days added on Tuesday, it has hit the maximum in an index of stringency designed by the United Kingdom’s Overseas Development Institute. But its economic response has been among the weakest, with an outlay of less than 1% of GDP compared to 10% in the case of the United States (US), 16% in Malaysia and a staggering 20% in Japan. It is important to dismiss the argument that India is poor and hence cannot be expected to do what richer countries have done. When a response is classified as weak, the evaluation is not in terms of absolute sums of money, but of the outlay in relation to a country’s capacity measured by its GDP.
As economic policy in India following the onset of Covid-19 must address both the relief made necessary by the lockdown and restoration of the level of activity after it is lifted, we may consider these two aspects together, terming the overall response needed as “stimulus”. What should the extent of this fiscal stimulus be? The level of the US stimulus may be taken as a benchmark. Concerns have already been expressed that a stimulus in India should be approached with caution as it has implications for the fiscal deficit. At 10% of GDP for 2019-20, the stimulus would amount to approximately ₹20 lakh crore. This may come across as a huge figure.
However, it is actually quite close to the direct loss of GDP due to a month’s lockdown, estimated as a 12th of annual GDP. If we are to take the multiplier to be 1.25, the final figure for loss due to the lockdown will exceed ~20 lakh crore. So, with a fiscal stimulus amounting to 10% of GDP, we would be no more than compensating for the economic shock that accompanied the lockdown.
Now, what of the implications for the fiscal deficit? A stimulus of ~20 lakh crore by the Union government would lead to an estimated deficit of approximately 14% of GDP in 2020-21. The figure is arrived at assuming that nominal GDP will grow at 6% (2% real output growth plus 4% inflation), and that so would public revenues. Public expenditure has been calculated by adding the proposed stimulus to the budgetary estimate for 2020-21. These can only be ballpark figures. What are we to make of the estimated figure of 14% of GDP for the fiscal deficit implied by a stimulus package of 10% of GDP? Well, as we are working with the figure for the US stimulus as a benchmark, it may be mentioned that one published estimate of the deficit implication of the US stimulus of two trillion dollars is that it will lead to a fiscal deficit of 14%. So, what is being proposed here is not unheard of.
Though Prime Minister Narendra Modi has stated “Jaan bhi aur jahan bhi”, implying that the economy cannot be ignored even as we are engaged in saving lives, the government is yet to announce a stimulus beyond a meagre relief package of ₹1.7 lakh crore.
Some economists look askance at the proposal for a fiscal stimulus on grounds of macro-economic stability. However, for now, India has substantial stocks of foodgrain and reasonably high foreign exchange reserves. In its last assessment, the Reserve Bank of India (RBI) figures show reserves exceeding outstanding short-term debt and cumulative portfolio capital inflows. Finally, crowding out of private investment can be avoided by the RBI absorbing the government bonds that will have to be issued. Before viewing this mechanism with horror, it would be worth recalling that growth accelerations have taken place in India at times when the budgetary deficit was monetised through central bank accommodation.
However, it is important to go beyond the numbers and imagine the role of fiscal policy in creating the economy that we value. If there is anything that this pandemic has done for us, it is to expose the parlous state of the health infrastructure in India. In any reconstruction of this infrastructure, first would be hospitals, primary health centres and laboratories, but we are also constantly reminded of the poor state of public health services, extending from sanitation to waste management. We have few public toilets, inadequate sewerage or assured water supply for the majority. The coronavirus pandemic has made us realise how important public goods are for a dignified and secure life. A focused public spending is central to the reconstruction that must now begin if we are to have a meaningful future.