The Hindu Business Line : Will the initiatives pay off?

India has initiated a number of monetary and fiscal measures to ease the effect of the global meltdown. Here’s a look at the likely impact of these on the various agents of the economy.

— A. Shaikmohideen

Will pump-priming work?

Devendra Kumar Pant

Globally, economic confidence is at its low and India is also feeling the pinch. The global economic crisis seems to have put the decoupling theory to rest.

Until October, Indian academicians and policymakers were talking of minimal impact of the global meltdown on the Indian economy. Not any longer, though.The effect on economies such as India has been mainly in the form of reduced capital flows and ex ports; the impact on export-dependent economies such as China has, however, been more severe.

Keynesian prescription

Countries are using both monetary and fiscal tools to stimulate demand. The Keynesian prescription to such a crisis is to increase public expenditure, especially in infrastructure, to stimulate demand and, thereby, put more money in people’s pockets.

But with the infrastructure sector becoming more capital-intensive than labour-intensive, higher spending on this sector may not directly increase money in the hands of the people.

GDP growth in financial year 2009 is estimated at around 6 per cent.

Measures undertaken

India’s response to the global crisis has been more or less similar to that of other countries. The monetary measures include reduction in the cash reserve ratio (CRR), the statutory liquidity ratio (SLR), repo and reverse repo rates and easing the ECB (External Commercial Borrowing) norms.

And the fiscal measures include a 4 per cent across-the-board reduction in central value added tax (Cenvat) on non-petroleum products, customs duty exemption on naphtha for power generation, export duty reduction on iron-ore lumps, and so on.

To provide a contra-cyclical stimulus, Plan expenditure is to be increased by Rs 20,000 crore, thus increasing total Plan and non-Plan expenditure to Rs 3,00,000 crore this fiscal.

One of the direct effects of the economic slowdown in the EU and the US would be declining export growth, which would slow manufacturing sector growth as well. The fiscal stimulus package provides an interest subvention of 2 per cent up to fiscal 2009, additional funds for full refund of terminal excise duty (TED) and CST (Central Sales Tax), etc.

What would be the likely impact of these monetary and fiscal measures on different economic agents of the economy?

Consumers

The impact would vary according to the production sector the consumer belongs. Across-the-board reduction in Cenvat on non-petroleum products and reduction in retail prices of petroleum products are the most beneficial policy measures, benefiting all classes of consumers through reduction in prices. The reduction in Cenvat will have impact on countervailing duties on imports as well.

The global economic slowdown has resulted in commodity prices declining. Lower commodity prices coupled with reduction in Cenvat would increase the real purchasing power of consumers.

Increased liquidity and the reduction in interest rates would allow banks to lend to consumers at rates lower than those that prevailed a few months back. However, it will take some more time before interest rates come down to the earlier levels.

Loans of up to Rs 20 lakh given by banks to housing finance companies for lending to individuals will now be classified as priority sector lending. This would result in improved credit availability for budget homes.

Industry

Mr P. Chidambaram, as Finance Minister, had urged industry to reduce prices to stimulate demand. The monetary measures will lower interest rates and enhance the flow of funds to industry. Reduction in the reverse repo rate to 5 per cent will encourage banks to lend to the real sector rather than park their funds with the RBI.

Easing the ECB and FCCB (Foreign Currency Convertible Bond) norms, including buyback of FCCBs, would increase funds availability and allow corporates to undertake capital expenditure.

Exporters

Among all the economic agents, exporters are facing a more difficult time. While a strengthening rupee has dented their profit margins, a slowdown in major export markets — the EU and the US — has resulted in a decline in exports and job losses in certain sectors.

While the measures taken by Government, such as reduction in pre- and post-shipment export credit rates, additional allocation for export-intensive schemes, refund of TED and CST, backup guarantee to ECGC (Export Credit Guarantee Corporation) and service tax refund, are welcome, the situation is unlikely to improve unless the economic fortunes in our export destinations improve.

Government

Through the monetary and fiscal measures, the Government is trying to boost domestic demand and negate some of the adverse effects on the growth momentum.

While corporation tax, personal income-tax and service tax collections during April-October 2008 are higher than the budget estimates, customs and excise duty revenues have been lower. Moreover, the impact of global turmoil is likely to be more severe in second half of the year. In these circumstances, it will be very difficult to achieve the revenue buoyancy attained in the last few years. Also, the fiscal stimulus package and supplementary demands could result in large fiscal slippages.

(The author is Associate Director, Fitch India Ltd. The views expressed are personal. blfeedback@thehindu.co.in)

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