The Hindu Business Line : Time to go fiscal?

The collapse of the financial system in recent times has led to freezing of debt markets throughout the world, with financial institutions refusing to lend to each other, forget about firms in other sectors such as manufacturing, getting cash. The usual policy employed by central banks in such situations is altering the monetary policy. By cutting interest rates and reducing CRR, central banks expect to defreeze markets so that lending can begin again.

Tinkering with rates

It is easy for the central banks to take such steps as they are freer from political compulsions and monetary policy operations are far quicker than others. This has resulted in co-ordinated rate slashes throughout the world with rates now hovering near 1 per cent in the US and Japan. European banks followed suit, albeit to a lower extent, for the fear of inflation. In India, the RBI has been reducing CRR and repo rates after raising them over the last couple of years.

However, there is only so much you can do with the monetary policy, for the rates can’t go below zero, and the problem has now moved beyond corporate players.

There is a slowdown in consumer spending the world over, pointing to a fall in private spending. If the “clinging to cash” syndrome continues at every level from foreign investors to households, monetary policy may not help and one may have to resort to fiscal policy measures.

Fiscal policy, though, is not usually preferred because the measures that will be required, like tax cuts and hike in Government expenditures, are tough to roll back and can harm the economy in the long run. But, at times, when banks are just not willing to make a move, there is no solution left. Besides, the fact that in an environment where everyone is running for safe assets and rates are low, it would be substantially easier for Governments to raise money on favourable terms without crowding out private investments.

Needed, a fiscal push

It is not possible for everyone to go in for an aggressive fiscal push. For example, in the developing world, China has been running a current account surplus and has huge foreign reserves. Countries such as India, which have a deficit, will find it tough to go in for such a solution, as creditworthiness will be effected. In the developed world, the US, in spite of running the biggest current account deficit, can use fiscal stimulus because Treasuries are considered to be the safest investment worldwide. Several countries in the Eurozone and China are considering such a package. At the G-20 meet, several members were unanimous on the need for a fiscal push.

However, fiscal steps are not the panacea. Such measures can become can lead to defaults, stoke inflation or push up interest rates. What is needed is a fiscal package with definite targets concerning deficit figures and a timeframe to implement it.

(The author is a student at IIM, Ahmedabad.)

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