Rationale behind the package

Govt seems to be preserving some firepower

The ~20-trillion economic package, announced by the government last week to deal with the impact of Covid-19, has been termed inadequate by many commentators. The package relied mostly on liquidity measures announced by the Reserve Bank of India (RBI) and extending credit to various sectors of the economy. As a result, the fiscal outgo has been just about 1 per cent of gross domestic product (GDP). Explaining the rationale for limited fiscal intervention, Union Finance Minister Nirmala Sitharaman said in an interview with this newspaper that the government had learnt lessons from the actions after the 2008 crisis and did not want to repeat the “same mistakes”. After the 2008 financial crisis, the United Progressive Alliance government is perceived to have delayed the rollback of the stimulus measures in time, and that resulted in a high fiscal deficit, high inflation, and an unsustainable level of current account deficit, leading to a near-currency crisis in 2013.

Clearly, the government does not want to risk financial stability to increase expenditure. Even at the current level, taking into account the revised borrowing target of the Centre and increased deficit limits for states, the combined deficit would easily cross 10 per cent of GDP in the current year. There will be challenges in financing the deficit. Additional borrowing worth, say, 5 per cent of GDP could become difficult for the markets to handle since the government is unwilling to borrow directly from the RBI. It is likely that government borrowing will be indirectly supported by the RBI through open market operations to keep the yields in check. However, it remains to be seen as to what extent the central bank would be able to support the borrowing as the system is already flush with excess liquidity. While the lockdown has led to a simultaneous demand and supply shock, it is not clear how soon the broken supply chains can be brought online with a large reverse migration of labour and social-distancing norms. Therefore, opening up the economy could see an increase in prices, at least in the near term. With incomplete inflation data, judging the overall situation would be difficult for the monetary policy committee, and excess liquidity will add to the problem.

At another level, the government seems to be preserving some firepower. It is still not clear how long the virus will last and how sustained would be the economic damage. Thus, it is possible that the government would need to make more interventions at a later stage in the financial year. The government has also done well to not consider the option of monetising the deficit at this point. If the government starts doing so, it would be difficult to contain and could end up creating bigger macroeconomic problems. Further, although the finance minister said that credit rating had to be a relative exercise and the whole world was affected by the pandemic, it could have played an important role in deciding the extent of intervention. Irrespective of the potential implications, an added uncertainty in terms of a rating downgrade to junk will not help India at this stage. In terms of reforms, the government has done well to reiterate its intent, but will have to walk the talk this time around. It also needs to broaden the canvas to minimise the legal hurdles for businesses across the board.