The New Year has begun with yet another instalment of monetary stimulus from the RBI and fiscal stimulus from the Government of India. The second instalment of fiscal stimulus announcement comes a month after the first, and this time in tandem with the RBI’s easing of monetary policy announcements. The major monetary policy measures include reduction in the CRR by 50 basis points, reduction in the Repo and Reverse Repo rates each by 100 basis points. The important among the fiscal stimulus measures include permitting the states additional fiscal deficit amounting to half a percent of GDP, enabling the IIFCL access to funds amounting to Rs 30,000 crore through tax-free bonds, allowing the developers of integrated townships and infrastructure-dealing NBFCs access to external commercial borrowings, removal of interest rate ceiling on commercial borrowings, increase in the FII limit in corporate bonds from $6 billion to $15 billion, restoration of DEPB to pre-November rates until December 2009 and assistance under the JNURM to buy buses for urban transport systems. Of course, the impact of monetary easing will depend on actual lowering of lending rates by the banking system and actual increase in borrowing by the business community. Similarly, fiscal measures may not immediately trigger increase in aggregate demand as they may work with a lag. It is precisely for this reason that the spending departments should prioritise their programmes and work out action plans for implementation.
With these measures, the government has once again shown its proactive approach in fighting the economic slowdown. Indeed, fiscal measures by themselves may not add up to much. That is because, our failure to make the needed adjustments when the economy was on the upswing has left very little room to manoeuvre. In fact, the second supplementary demand amounting to Rs 53,000 crore passed by Parliament in December, along with the first, means that the underestimation of expenditures in the budget was almost Rs 290,000 crore or 39 percent of the originally budgeted expenditures. An overwhelming proportion of this actually accrued last year and, it was simply postponed to the current year to show adherence to the FRBM targets.
In many ways, additional spending enabled in the two supplementary grants, though they pertain to expenditure commitments of the last year, must be taken as a part of the stimulus package. Fiscal stimulus such as pay increases and projects which place the purchasing power in the hands of the people with low marginal propensity to save has immediate impact in augmenting aggregate demand. Similarly, expenditures on augmenting infrastructure could remove the infrastructure constraints in the medium and longer term, add to productivity increases and can have greater multiplier effects, but their fast implementation is the key to their effectiveness. Unfortunately, our recent experience in infrastructure implementation leaves much to be desired. The problem here is not with enabling larger spending but with its implementation. Ninan in his Weekend Ruminations (BS, January 3) has eloquently alluded to the governance problem. The simple point is that even when enabled, there are lags and leakages and to consider that aggregate demand will increase by the amount of expenditure enablement would be simply erroneous.
The most important exercise required is to prioritise the ongoing projects and speed up their implementation by every government department. The critical question, however, is whether the various government departments are willing to shed their BAU inertia. In many ways, immediate fiscal stimulus can come from spending on social sectors as an overwhelming proportion of this is on wages and salaries. Besides giving thrust to the planned expansion of school as well as higher, particularly technical, education, speeding up programmes on vocational education should be given a thrust. The impact of expenditures incurred on education and healthcare is immediate. These are mainly in the states’ domain.
Given that the there are only three months left in the current financial year and the code of conduct would come into force once elections are announced, one should not expect any more fiscal stimulus package for the year and the focus should shift to fast implementation. Indeed, there will have to be continuous monitoring of monetary policy and when we have the SLR of 24 percent, it is possible to reduce the CRR even from the present level of 5 percent.
One area where fiscal stimulus package still needs to be worked is at the state level. This is necessary not only because states have co-equal responsibility in providing physical infrastructure and overwhelming role in providing social services, but also their action needs to be coordinated with that of the Centre. States incur 55 percent of total expenditures and yet, states have not taken any initiative so far. The “fiscal perversity” thesis propounded by Hansen and Perloff in 1944 found that subnational governments, given that they were not allowed to have deficits, were forced to follow pro-cyclical policy during the Great Depression. In the present context, states could see a sharp decline in their own tax revenues as well as devolution from the Centre and as they are required to contain their deficits as mandated in their fiscal responsibility legislations, they may be forced to follow a pro-cyclical policy. Of course, the increase in the fiscal deficit limit to 3.5 percent is welcome, but additional measures are necessary to calibrate coordinated policy.
To kick off the states’ participation, the Prime Minister should call a meeting of the state chief ministers and impress upon them the need for coordinated action. Besides emphasising prioritisation and speedy implementation of various infrastructure projects and flagship programmes, the Prime Minister could agree to bear half of the cost of implementing the new pay scales. This would provide the states the necessary room to coordinate their action with central policy. It is also important for the states to work out a clear scheme of project/programme implementation. As mentioned by the Prime Minister in his address to the Indian Science Congress, the impact of the slowdown will be greater next year and the states should coordinate their policy stance with the Centre. Indeed, there will be greater challenges in the next year and we should be prepared to face them.
The author is Director, NIPFP. Comments at email@example.com