New Delhi: You must have heard or read some version of the following in recent weeks: "Narendra Modi government needs to increase spending", “A fiscal stimulus is the need of the day", "The government needs to follow counter cyclical measures", "The government can overshoot its fiscal deficit target for the year because demand needs to be stoked” etc.
News18 breaks down the economic jargon and explains why everything related to economy and business is suddenly focused on fiscal stimulus.
What is a fiscal stimulus package?
During a downturn governments can step in with a set of measures to reinvigorate the economy. Most often these involve increased spending by the government to increase employment and general demand in the economy, which acts as a signal for companies to increase production, which in turn will lead to more hiring and so on through the virtuous economic cycle.
Why does India need a fiscal stimulus?
Picture the Indian economy as an airplane with four engines: Three of the four engines (exports, private investments and consumer demand) are sputtering and the last engine (government spending) is keeping the airplane afloat. Also, anecdotal evidence suggests that unemployment has increased. Hence, the need to provide support for the economy.
Breaking down Fiscal Policy
The government could lower taxes in order to put more money in consumers hands so that they spend more. However, since India has switched to the Goods and Services Tax the government may find it difficult to cut indirect tax, unless it reduces the rates on petroleum products. The government will have to wait till the next budget to announce a cut in Income Tax.
The other option is to increase government spending – building more ports, highways, bridges etc – which stimulates construction activity and reduces unemployment.
So why are some people arguing against a fiscal stimulus?
In order to increase spending the government has to borrow money, since its tax revenues cannot meet the shortfall. However, a government borrowing from the open market reduces the pool of money available for companies to borrow, and raises their interest costs. It is also argued that deficit spending by the government increases inflation, which in turn hurts the economy.
Some economists argue that the benefits of a fiscal stimulus are overstated since the extra spending will come out of the government’s tax revenue, in other words, from the productive activities of the private sector, and so this is vigourously opposed by them.
Are there instances in the past when India gave a fiscal stimulus?
Yes. In the aftermath of the 2008-09 global economic crash the government cut the CENVAT rate by 4% and increased spending on infrastructure and exports. The NREGA also paid money into rural hands, thus ensuring that rural demand was not hit. These measures ensured that economic growth did not dip below 7%.