Within days of the “first” fiscal stimulus of December 7, 2008 there was mounting agitation for a second fiscal stimulus, fuelled by reports of a rapidly slowing economy and, perhaps, the swiftly spreading international fashion for massive fiscal stimuli (you could call it “Keynes unbound”!). I too was getting a little agitated, especially after the second Supplementary Demand for Grants for Rs 55,000 crore whizzed through Parliament, largely unnoticed, before Christmas. By then, my crude calculations, based on public official data and statements, were pointing to a Central Government true fiscal deficit of around 8 percent plus of GDP for 2008/9 and a combined (centre plus states) fiscal deficit of around 11 percent plus of GDP, a new high in India’s post-Independence history. Surely not, you might say, incredulously.
Well, judge for yourself, dear reader. Start with Mr Chidambaram’s (now risible) February budget estimate of 2.5 percent of GDP. Add the monster October Supplementary Demand of over 4 percent of GDP (2 percent in cash and over 2 percent in off-budget items, mostly petroleum and fertilizer subsidies masquerading as bonds). Add 1 percent for the second (December) Supplementary, which is mostly cash and some fertilizer bonds. Add, conservatively, a revenue shortfall of 1.5 percent of GDP because of post-budget tax concessions and economic slowdown. Subtract 1 percent for guestimated 3G telecom auction revenues and some expenditure savings. And you get 8 percent for the Centre. Add 3 percent for the States’ fiscal deficit and we are right up there at 11 percent of GDP Table A. And that’s without knowing the scale of a possible third Supplementary in February.
| Table A: Fiscal Deficits (% of GDP) | ||||
| 2001/2 | 2003/4 | 2007/8 | 2008/9 | |
| Centre | 6.2 | 4.5 | 3.4a | 8-9b |
| States | 4.2 | 4.4 | 2.3 | 3 |
| Combined | 9.9 | 8.5 | 5.6 | 11-12 |
| Notes: a. Consists of 2.8 percent of GDP as per Provisional Accounts and 0.6 percent of off-budget items (mainly, petroleum and fertilizer bonds). b.Includes off-budget items of about 2.5 percent of GDP Sources: RBI Handbook of Statistics on Indian Economy and Annual Report, 2007/8 for data up to 2007/8. | ||||
So much by way of explaining my nervousness about what the Fiscal Stimulus 2.0 (as the press has dubbed it) might contain. I fully agree with the conventional wisdom that the economic situation post-September called for a sizable stimulus. But going from a budget estimate for the combined fiscal deficit of 4.6 percent of GDP (see RBI Annual Report for 2007/8, Table 2.56) to 11 plus percent already seemed excessively stimulating to me. It was with considerable trepidation that I read the morning papers on January 3, reporting on the coordinated monetary-fiscal package announced by the authorities the day before. Imagine my relief when I realized that Fiscal 2.0 was remarkably non-fiscal! Consider the big items, excluding minor adjustments of duties/exemptions. As Table B points out, most of the major items are not fiscal, that is, there is no big new government expenditure or tax relief. Item 3, the SPV for liquidity support to NBFCs, will be essentially a conduit for RBI refinancing. The additional tax free bonds for IIFCL for infrastructure financing, Item 6, will entail revenue loss, but not till the next fiscal year. The planned recapitalization of PSU banks will also happen in FY 2009/10 and is likely to be a non-cash, off-budget item.
| Table B: Fiscal Stimulus 2.0: Main Items | |||||
| Item | Ticket Size in Rs Crore | Fiscal | Quasi- Fiscal | Non- Fiscal | |
| 1 | Relaxation of ECB Guidelines | — | — | — | X |
| 2 | Raising FII investment limit in corporate bonds from $6 bn to $15bn | — | — | — | X |
| 3 | SPV for liquidity support to NBFCs | 25,000 | — | — | X |
| 4 | Higher credit targets for PSU banks | — | — | — | X |
| 5 | Additional market borrowing for states | 30,000 | — | X | — |
| 6 | Additional tax free bonds for IIFCL for infrastructure financing | 30,000 (FY2009/10) | — | X | — |
| 7 | Recapitalization ofPSU banks | 20,000 (FY2009/10) | X | — | — |
| 8 | Accelerated depreciation for purchases of commercial vehicles | ? | X | — | — |
| 9 | RBI credit line to EXIM bank | 5,000 | — | — | X |
All of the nine items listed in the table are targeted at stimulating higher economic activity in some form or other. But only one is truly fiscal and with implications (modest) for FY 2008/9. Indeed, it’s a clever package, which implicitly recognizes the absence of fiscal space in the current fiscal year. Except for the first two items, there are good reasons to undertake these initiatives. Why am I concerned about the first two items? Well, I believe our external payments situation has entered a somewhat uncertain terrain, with falling exports of goods and services, a continued high trade deficit, some uncertainty on levels of remittance inflows, declining net equity inflows, reduced forex reserves and sizable recent increases in external debt. As of March 2008 our external debt stock was at a record high of $221 billion (up $52 billion from the previous March), of which a rather high 20 percent constituted short-term debt, up from 15 percent the year before. Against this background, the major relaxation of ECB guidelines and raising of the cap on FII investment in corporate bonds strikes me as a trifle adventurous. Fortunately, there may not be much by way of debt-augmenting inflows in the current international environment.
Let’s turn briefly to the concurrent, monetary policy package announced by RBI, namely a 0.5 percent reduction in the CRR (down to 5 percent) and a one percent reduction in repo and reverse repo rates, down to 5.5 and 4 percent, respectively. Frankly, I see little justification for the reduction in CRR at a time when the RBI was absorbing Rs 40,000 to 60,000 crore of excess liquidity through LAF operations in the overnight call money market on a daily basis. It will have little impact on reducing market interest rates, the principal area of current concern. On the other hand, it makes the daily management of the forex market a little more problematic, since the action could put some downward pressure on the exchange rate.
The reduction in repo and reverse repo rates could help reduce market interest rates. But, as we have seen from the previous reductions in these rates by 3 percentage points in the past three months, the impact on actual commercial rates for bank lending/borrowing is attenuated by a number of factors, including: the recent history of high-cost borrowing by banks; higher perceived risk of borrowers operating in a markedly worse business environment; the downward stickiness of bank deposit rates because of the politically-determined floor (around 8 percent) on interest rates available in “small savings schemes” run by the post office and provident funds; and unduly elevated inflation expectations linked to continued high rates of CPI inflation.
Perhaps, if we want to accelerate the decline in commercial bank interest rates, we need to think a little out of the box. One suggestion would be to try a small, temporary subsidy on all new commercial bank lending for a few months. Concretely, we could consider an across-the-board government subsidy of 3 percent (of loan value) for all new commercial bank loans made in the next three months, with the subsidy dropping to 2 percent for the following three months and to 1 percent in the third, and final, three-month segment. The RBI has the experience of administering such a subsidy, which currently exists on bank loans for agriculture. Back-of-the envelope calculations suggest that such a time-bound, sliding subsidy would cost around Rs 7,000-8000 crore, or just over 0.1 percent of GDP. I wouldn’t suggest such a heterodox measure in normal times. But unusual times call for unorthodox measures.
The author is Honorary Professor at ICRIER and former Chief Economic Adviser to Government of India. Views expressed are personal