Stimulus
Opinion

Stimulus

K.M. Chandrasekhar

K.M. Chandrasekhar

Several times during the past many weeks, even months, I have written about the state of the Indian economy. This time again, following the “stimulus” given by Finance Minister Nirmala Sitaraman, I am obliged again to write on the same subject and the strengths and weaknesses of the present government action.

While the present stimulus may be a reaction to the pandemic, India’s economic woes started months earlier. If we are to identify a starting point, I would say it was the act of demonetisation. The sudden withdrawal of 86% of currency from the market led to a sharp decline in demand, as business units, particularly small and medium enterprises, both in the industrial sector and the service sector, struggled to stay afloat. Their problems were further aggravated by rigid banking regulations on non-productive assets and strong regulatory action, especially in matters relating to taxation.

Effective government action was obviously needed on the demand side. Instead, the government chose, late last year, to announce corporate tax cuts. Corporates would, in normal times, have gained from such a reduction but these were not normal times. What business wanted then was a growing market for their products. When, instead, buying power declined, we entered a cyclical phase, involving fall in incomes, rising unemployment, fall in domestic savings and investment, sharp decline in capacity utilisation. Our exports also declined as the global economy slowed down with the advent of Trump and his aversion to global free trade governed by mutually agreed multilateral trade laws.

It was possible at that time to correct the situation. We would then have entered the Covid phase with a stronger economy. In my piece, ”Plunging Demand, Flagging Economy”, published in late January, I wrote, “India, with its huge market, has the strength and the resources to pull itself out of the crisis. Some reform measures, like corporate tax cuts and bank mergers have been announced. These are supply side measures. For supply side measures to work, demand has to pick up.”

Nothing tangible happened. The Budget, we thought, would galvanise the economy. It was listless and insipid. In my weekly column titled “Nero fiddles” published in these pages three weeks ago, I had described the situation thus, “The inability of economic policy makers, manifested over the last couple of years, either to identify the real issues or to formulate a realistic and timely response, makes me very apprehensive of what lies ahead of us. The stubborn adherence to business-as-usual economics in times of crisis and the incapacity to adapt to changing situations is a worrying factor. If demand fails to pick up, if incomes fall and unemployment rises, we could get into a vicious cycle of poverty from which it will be increasingly difficult to bale out the economy. The delay in announcing a sharp, self liquidating stimulus and financing the much greater requirements of State Governments will have a far greater impact on the poor rather than the well-off.”

Covid and the knee-jerk reaction of imposing a total lockdown on the country with barely four hours notice made the situation much worse. The insensitivity shown to the poor among us, in particular those eking out a precarious living in areas far from their homes, was something we had never expected to see. Most of us were born in post-Independence India. We have heard of the travails of Partition and the misery inflicted on millions on both sides of the border with Pakistan. We have heard of the mass movement of ill-prepared people that took place then. We never expected to see similar callousness displayed in a free and democratic India. While other countries announced strong stimulus packages, described at length in my column “Nero fiddles”, published a couple of weeks ago, procrastination appeared to be our preferred response

The Prime Minister’s announcement on Sunday of a stimulus of ₹ 20 lakh crore rekindled hope. The Sensex went up by 600 points on Monday. It would normally have gone up by much more but for the fact that business has begun to perceive a credibility gap in the announcements made by this government. And, indeed, when the Finance Minister did announce a package, there was, as usual, disappointment. The main element in this package was a loan to medium and small industry of ₹ 3 lakh crore, where Government assumed contingent liability by guaranteeing 100% of each loan. This was, of course, a significant move and, if implemented effectively, it could help to bail out many failing units. This was supplemented by other measures such as support for stressed units, widening the definition of medium, small and micro units and even a provision for equity infusion in such units. Contingent liability was also taken for loans to NBFCs, housing finance companies and micro finance companies. This too is a good move which would benefit MSMEs which are financed by NBFCs and increase the availability of retail loans which could spur consumption. The guaranteed line of credit for power distribution companies is another important step which will help revitalise the stressed power sector. There was no linkage of these loans to employment as in UK and Germany.

These measures fell considerably short of expectations. There were two main shortcomings. One was that the issue of lack of effective demand had again not been addressed. The measures on the demand side, such as reduction in EPF contributions and in tax deducted at source will not have any material impact on incomes and on spending. Dr. Srivastava, member of the Advisory Council to the 15th Finance Commission, said, “ A clear feature of today’s announcement is that most of these are basically supply side measures aimed at activating businesses in the MSME, real estate and NBFC sectors. Generally, stimulus measures are aimed at boosting demand either by government spending on its own account or increasing disposable incomes of households through cash transfers or tax concessions.” Andy Mukherjee of Bloomberg made the same point, writing in the Economic Times( 14/5), when he said that “for the stalled credit engine to restart, firms need both new orders and the assurance of timely payments.” The stimulus provided a line of credit to MSMEs, but where and how will they sell their products when demand is subdued?

The second major problem with the package is that it will be implemented through financing institutions. Unless the banks, already under heavy regulatory pressure from RBI and investigative agencies, are confident and active, these measures may not yield the expected results. The RBI has, in the past, come out with many measures to infuse liquidity but banks have been reluctant to take the next step. Will this package also meet the same fate? The market seems sceptical. The Sensex fell 800 points the next day and 300 points the day after.

On Thursday, the Finance Minister announced another set of measures, aimed particularly at providing succour to the needy. This includes supply of food grains and pulses ,a single ration card for use throughout the country, subsidised housing on a larger scale for a longer time, a special credit facility for street vendors, additional resources for work in the tribal sector, inclusion of more farmers, fishermen and those engaged in animal husbandry in the Kisan Credit Scheme and additional funds through NABARD for small and marginal farmers. Here again, excessive dependence on intermediary institutions and bureaucratic inertia may whittle down the impact of the stimulus.

One glaring fact stands out very visibly in both the tranches that have been announced till low: the complete lack of faith of the Centre in State governments and in Panchayati Raj institutions. The States and local bodies are best equipped to deal with the problems of the unorganised sector, rural poverty and local unemployment. Instead, the Centre wants to do everything by itself. Nothing has been done to strengthen the finances of States, either by direct transfer or by raising their borrowing limits. Having agreed to give up their indirect taxation powers, now subsumed in a poorly implemented GST scheme, the capacity of the States to raise resources is severely curtailed. The States are in the forefront of the battle against Covid and rising poverty levels. Ignoring them, so completely in the stimulus packages so far announced is a retrograde step, not in the interests of the country. Let not the outcome of the pandemic be the unravelling of our federal democracy.

The stimulus packages thus far have touched only the fringes of a problem of colossal dimensions. There is no clarity on how demand will be stimulated, employment opportunities created, severely damaged industries like automobiles, tourism and wholesale and retail trade revived. There is no indication on whether there will be any tangible action to redress many decades of neglect in the health sector. Nothing has been said yet on government policy being guided hereafter by the principle of maximisation of public welfare.

The Prime Minister has stressed the need for self sufficiency going forward. The stimulus package contains one measure, reservation of some portion of government procurement to Indian industry. It is not clear whether this is in conformity with multilaterally agreed trade rules. However, if self sufficiency is going to be our creed, as America First is for Trump, there is need for a great deal of reflection, introspection and public debate. Self sufficiency used to be our clarion call in the first three decades after Independence but, later, we chose the path of global integration. Are we going back again to Gandhian and Nehruvian thinking? Will the infant industry mindset once again resurface?

It is too early to write off the stimulus packages, as the FM seems to be reluctantly announcing it bit by bit and we do not know how the whole will look like. At the end of the day, one hopes that the mountain of hope created by the Prime Minister does not give birth to a puny mouse

The facts and views expressed in the article are those of the writer.

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