The Hindu Business Line : Stimulus for fiscal incentives

Fiscal inaction may be risky. In an uncharacteristically casual statement, Mr P. Chidambaram, who recently took over as Home Minister, commented that the Indian economy is not facing a recession and that its estimated growth rate is a respectable 7-8 per cent.

In his favour, unlike the US, we, in India, are not facing a recession defined in classic terms. However, there has been a fall in growth for two quarters. Recession is stated to take place when the economy fails. Signs, however, portend a sharp downturn in economic growth in India.

The recently published analysis of leading indicators by ICRIER analysts shows that the country’s growth rate may even slip to the sub-7 per cent level in the coming quarters.

In a technically sophisticated analysis, some economists — Rajiv Kumar, M. Joseph and D. K. Singh — cautioned that the growth, which is stymied by higher interest rates and fall in credit growth, could even be as low as 4 per cent in 2009-10.

The point to note here is that signs of decline in growth are already all around us — even if we ignore the effect of the global slowdown.

Signs of degrowth

To cite an instance, recent news reports show that over 2,000 auto component manufacturing units in Jamshedpur and nearby areas may face closure. Already, about 600 such units have closed down. This follows the decision of major auto manufacturers, such as Tata Motors, to cut down production.

These units are usually small- and medium-scale industries, which depend on auto manufacturers for their orders. In particular, the recent decision of Tata Motors’ commercial vehicle plant in Jamshedpur to shut down for eight days came as a blow to for many of the ancillary units.

The same is the case with other commercial vehicle manufacturers, who have curtailed production. The production cuts resorted to by auto manufacturers are a consequence of the economic slowdown caused by tight monetary policies, including rise in interest rates and reduced credit flow from NBFCs. It is imperative that timely steps are taken to correct these features of economic de-growth, which are mostly of our own making.

Vulnerable to global volatility

The authors mention that this decline is in addition to the fall in demand arising from the global slowdown, especially in the American market. And domestic sectors such as textiles and software, with their export dependence, are the worst hit.

We also have to contend with the fact that American auto majors are facing a sharp decline in demand due to falling purchasing power. This, in turn, is reflected in loss of orders for some of our auto component manufacturers, whose exports were linked to the US auto industry.

Incidentally, at the time of the US financial turmoil, many Indian economists tried to suggest that India, being less export-dependent, was decoupled from the US. The theory of decoupling has been proved false and India remains exposed to the prevailing volatility in global demand.

Revive demand

Not all is lost however. Much can be achieved by resorting to a a mix of fiscal and monetary measures to boost the waning demand. This, is turn, would enable GDP to grow at 7-8 per cent, which is the least that we should aim at, given our performance over the last five years.

The fear of some critics in regard to a fiscal stimulus is that India’s fiscal deficit, that of the Centre and the States together, has already been running at around 10 per cent, as shown by the latest Budget. In addition, there are a number of off-Budget items, such as oil bonds, which effectively increase the gross fiscal deficit/GDP ratio.

It is argued that, given these facts, any further fiscal expansion in the form of subsidies or tax concessions to ailing industries will result in total fiscal unsustainability and a rise in the debt burden. There have been respectable voices arguing that the “concord” between the RBI and the Government not to resort to unrestricted borrowing from the central bank should be preserved.

While I respect the validity of this argument in general terms, the particular situation, where India is facing a dramatic decline, on top of a global crisis, deserves to be treated differently. All methods should be used to enable the revival of demand and employment. Manufacturing growth should be put on a sustainable footing.

Structural bottlenecks

It has been argued, in particular, that the defects lie in lack of infrastructure, such as roads and shortage of power. The economy can surely benefit from paying more attention in clearing these structural bottlenecks. While I concede the merit of the argument that structural and procedural bottlenecks exist and these should be rectified, the argument does not preclude the case of fiscal incentives and need for action to boost demand.

The argument is made stronger by the fact that inflation has shown a declining trend in recent weeks. The fall in crude oil price to as low as $40-45 for the Indian basket indicates that there is scope for an increase in monetary aggregates, which may be implied by fiscal deficit expansion. A monetary contraction to fight inflation may not be justified in these circumstances. The fact that oil prices have shown a sign of decrease may also enable the Government to restore balance on the oil marketing companies’ front. The evolving political situation also dictates that it makes sense for the Government to pass on the fall in the international crude oil price to the consumer.

Linking domestic prices to international crude oil prices will allow the Government to resort to increases in case of a spike in global prices.

Suggestions have been made that the Government should resort to excise duty reduction to encourage manufacturers to reduce prices. This makes sense. Indeed, it makes far better sense than the appeal of Mr Chidambaram to corporates to reduce prices suo motu. If corporates have to protect their bottomlines, the Government must reduce exciserates.

Fiscal rectitude is in order for countries in normal times. But the current slowdown does justify fiscal stimulus. One hopes the fiscal stimulus package just announced contains enough safeguards to ensure that inflationary concerns are addressed.

It is hoped that the fiscal incentives package will restore the growth impulses in the Indian economy in the wake of the global financial crisis.

(At the time of writing this article, only the outline of the fiscal stimulus package has been announced. My remarks on the subject have to be seen in this context.)

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