What is the issue?
- India’s GDP growth in the April-July quarter slumped to 5.7%.
- Demands for unleashing a fiscal stimulus have grown stronger.
What is it?
- A ‘stimulus’ is an attempt by policymakers to kickstart a sluggish economy through a package of measures.
- A monetary stimulus will see the central bank expanding money supply or reducing interest rates to encourage consumer spending.
- A fiscal stimulus is one in which the government spends more from its own pocket or slashes tax rates.
- Stimuli puts more money in the hands of consumers and spending goes up – thereby encouraging demand & growth.
What is the logic behind?
- Concept - Proponents of fiscal stimulus, base their arguments on the Keynesian theory of macro economics.
- Keynes argued that even small direct interventions by the Government to prop up demand, can have a disproportionately high impact on economic growth due to the multiplier effect.
- The explanation - When demand in an economy stays weak for long, businesses stop investing in new projects, unemployment rises, income shrinks and consumer confidence wanes.
- This further hinders spending due to lack of money and thereby dampens demand – creating a vicious cycle.
- If the Government can step in with a fiscal stimulus, it revives business confidence, restarts projects, creates jobs and sets off a virtuous cycle of feel-good, demand and growth.
What was our previous experience?
- The 2008 Sub-prime crisis saw countries like US, Europe, Japan and China rolling out large fiscal stimulus packages.
- India’s too gave out a package then included export subsidies, excise duty cuts and Rs.10,000 crores for infrastructure financing.
- The government employees were also given a pay revision & a large order for new buses to replace public transport fleets was made.
- As a consequence GDP growth revived from 6.7% in FY09 to 8.6% in FY10 and to 8.9% in FY11.
- But at the same time, fiscal deficit of the government for FY09 rose to nearly 8% of GDP, from the projected 2.5%.
- Subsequently, when the stimulus was rolled back, growth promptly slumped.
What are the concerns now?
- The government currently faces a situation very much similar to the one in 2008.
- While generous public spending may boost investments & demand, the government will loose out on its fiscal deficit target that is currently pegged at 3.2 %.
- This may not go down well with foreign investor sentiments.
- Whether the economy will take off on its own once the stimulus wears off is also doubtful.
How does the future look?
- If the government decides to go with the stimulus it would have to identify its priorities clearly.
- Duty cuts on petrol, constructing of affordable homes, banks recapitalisation & cheaper lending to MSMEs are some options.
- While a stimulus will rejuvenate the economy through budgetary spending, the government would have to eventually earn it back.
- Hence, tax revenues through other means will ultimately pinch the citizens after a while.
Source: Business Line
