Financing the Covid-19 economic package

The government has been bold. Now don’t worry about inflation or capital flight, use the money financing route

The wait is over. It came in Prime Minister Narendra Modi’s fifth address to the nation in two months. The ending of his speech, which incorporated everything from Bharatiya sanskriti (culture) to solar energy, went off like a bomb. Just when most observers of the government’s actions since the coronavirus pandemic had more or less given up on its announcing an economic package, one far greater than expected was announced.

During the silence from the central government, some well-designed packages had been proposed from the outside. One by the Opposition had proposed a package of over ₹5 lakh crore. This concentrated on relief. While relief is vital and something expected from a government that implemented a lockdown without debate, it cannot address the subsequent revival of the economy. A package representing wider concerns and greater heft, amounting to ₹15 lakh crore, came from an industry body. At ₹20 lakh crore, the package announced by the prime minister exceeds even the latter.

Coincidentally, it exactly matches the quantum recommended in a proposal made in an article in these pages on April 15. A difference is that while the latter had proposed a pure fiscal stimulus of ₹20 lakh crore, the prime minister’s package includes the financial implications of measures taken by the Reserve Bank of India (RBI) so far and some relief offered in March. It is, therefore, a measure of the combined monetary and fiscal policy response to the exigencies of the moment. However, even if the monetary measures are taken to a sum of over ₹4 lakh crore, the package is large indeed.

At close to 10% of GDP, the stimulus is only slightly lower than what has been announced in the United States. The political element in the magnitude of the response cannot be overlooked. The announcement has come at a time when cases of infection in India are not just rising, but rising fast even though the world’s most stringent lockdown, with associated hardship, has been in place for seven weeks. The economy could no longer be ignored.

While the content of the package will slowly emerge, the prime minister’s speech suggests that it is comprehensive, covering most sectors of the economy. However, apart from the possibility that political considerations may end up spreading the outlay thinly, a technical issue remains.

Of the four areas of focus mentioned, liquidity is one; land, labour and laws are the others. Now, while liquidity enhancement by RBI is important, global experience points to its weakness as a method of reviving an economy that is in crisis. A central bank may enhance the capacity of banks through repo operations, but it cannot force them to lend. Judging by the volume of funds the latter have parked with RBI, it may be concluded that they are reluctant to do so, making it the right moment to contemplate negative interest rests on these holdings. The point is that the greater the share of liquidity-enhancing measures in this economic package, the less potent it will be.

After we have acknowledged the boldness of the announcement, we would be interested in knowing how the additional outlay is to be financed. For the moment, the government should seriously consider the money financing route as funding the deficit will raise interest rates. An objection encountered is that the former is inevitably inflationary. Actually, it is not more so than monetary easing implemented by the central bank.

For close to six decades, after the founding of RBI, money financing was routine. In the mid-1950s, there was much handwringing that the second five year plan was being deficit-financed. There was some inflation all right, but in seven years after launching the plan, the economy had sloughed-off the colonial rate of growth prevailing for half a century. By the time money financing of the central government’s deficit was discontinued in the 1990s, growth had accelerated two more times. Actually, a period of high inflation came after 2008, well after money financing was discontinued.

But recognising the possibility of inflation, the increased outlay now planned may be spent in tranches, holding expenditure back if there is a spurt in inflation. In addition to inflation, some Indian economists residing overseas have warned of capital flight if the fiscal deficit were to rise. India’s foreign exchange reserves currently exceed the volume of portfolio investment. Anyway, why would foreign institutional investors want to flee India exactly when, with the economic package just announced, it stands a chance of becoming the world’s fastest-growing large economy?

With the technicalities over, the irony of a government that has distanced itself from almost every aspect of the economic policy of early independent India now adopting its very premise is apparent.

Self-reliance was the motif of policies pursued in India in the 1950s, and the country industrialised quickly. In the next decade came the Green Revolution, which set the nation free from food imports. By contrast the “Make in India” initiative of 2014 has been less disruptive. May the freshly minted “Atma Nirbhar Abhiyaan” succeed.