Revival lessons from 2008 stimulus

When the global financial crisis occurred in September 2008, India’s growth rate over the previous years had been averaging 8.9 per cent. There was initially a sense of complacency that India would remain untouched as it had been cautious and had not deregulated its financial system. There was no exposure to the high-risk financial products that caused the crisis in the US. So, the precipitous fall that occurred in the Indian economy came as a shock. India’s integration with the global financial system had, in reality, become far greater than was assumed. By November, there was a crisis. The government acted swiftly and announced a major stimulus package as early as December 6, 2008, followed by two supplementary packages. These worked more speedily than expected by most observers. Recovery began — from the low of around 5.5 per cent growth rate in the last two quarters of 2008-09— in the first quarter of 2009-10 itself. The financial year ended with gross domestic product (GDP) again growing at 8.6 per cent.

 
The revival package was put together with the correct assessment that the economy was in a free-fall due to external shock of the global financial crisis, and that it needed immediate and strong stimulus measures to arrest the downturn and revive growth. The components of the package were chosen after close consultations with representatives from the major sectors of the economy. It was a combination of monetary easing and fiscal measures. The Reserve Bank of India (RBI) worked in close coordination with the government. The International Monetary Fund (IMF), normally a preacher of lowering fiscal deficits, sent representatives across the world advocating the use of fiscal measures for generating demand to arrest the downturn.

 
Normally, the RBI changes interest rates by 25 basis points at a time. Recognising the need for a strong stimulus, it departed from standard practice and announced the lowering of the repo rate by 100 basis points at one go. From September 2008, it progressively lowered the repo rate from 9 per cent to 5.5 per cent and the cash reserve ratio from 9 per cent to 5 per cent. It made available about Rs 4 trillion of additional liquidity through various measures. Liquidity ceased to be an issue in the financial system.
 

On the fiscal side, excise duty was lowered by 4 percentage points across the board. The intention was to increase demand with attendant multiplier benefits. The pay commission recommendations had been implemented and there was greater purchasing power with government servants who had also received arrears. This helped in increasing consumption. The inclination to increase investment in infrastructure was avoided. It was recognised that large projects have a long lead time from approval, to putting together land, inviting bids and then awarding contracts. Actual expenditure could occur only after a year. Given the scale of the crisis, additional expenditure needed to take place immediately to create more demand for domestic goods and services. An increase in plan expenditure of Rs 20,000 crore for the year was provided. Ongoing programmes, which could absorb additional expenditure immediately were identified. Out-of-the-box thinking led to unorthodox measures. To illustrate, grants were given for the purchase of buses under the Jawaharlal Nehru National Urban Renewal Mission for augmenting city bus services. Interest subvention of 2 per cent was provided for exports. Small scale enterprises and the housing sector received some special dispensation. Since the code of conduct for general elections was going to come into effect by March 2009, measures were identified to ensure they did not violate the code of conduct. Additional expenditure was made on ongoing programmes without any publicity. This required working in close coordination with the Election Commission and taking approval where needed.

 
A higher fiscal deficit as a result of the stimulus was envisaged. But this was to be for the short-term. In 2007-08, the fiscal deficit was only 2.6 per cent of GDP. In 2008-09, it rose sharply to 6.1 per cent. By the end of 2009-10, with growth having returned to earlier levels, fiscal deficit reduction to the pre stimulus levels should have become a priority. This did not happen. In 2011-12, it needlessly rose to 5.9 per cent from 4.9 per cent in 2010-11. Political economy makes increasing the fiscal deficit easy but reducing it difficult.
 
The present situation is qualitatively different and far more challenging. The persisting downturn is resulting in lower revenues and rising deficit, reducing the space for a fiscal stimulus. The financial sector’s return to health is still a work in progress. With hindsight, a rescue of the Infrastructure Leasing & Financial Services Limited, along with takeover of its management, may have been a better option as it would have avoided the crisis in the non-banking finance companies. There was the successful precedent of the bailout of UTI. A more vigorous resolution of coal and related problems of stalled private sector power projects would have eased the burden on the banks. The flow of additional financing for completing stalled housing projects could have been done earlier. The inability to get manufacturing going in electronics, IT hardware and solar power has led to booming demand being met by imports. Further, the 19 per cent real exchange rate appreciation by itself would have been enough to cause stagnation followed by a downturn.

 
However, the major learnings from the 2008-09 stimulus do have some relevance for the present. The foremost is taking a holistic view and implementing a set of measures having a critical mass so as to increase the likelihood of making an early impact. The efficacy of the means to achieve a desired outcome has to be carefully thought through. It is also important to assess the time needed for an intervention to deliver results. There are no standard fixes. There should be willingness to consider unprecedented steps and take  risks.
 
The writer is a former secretary, DPIIT