An Unfounded fear of the Fisc will Worsen our Economy

Livemint     22nd September 2020     Save    
QEP Pocket Notes

Context: Arguments against fiscal expansion lack validity and the Centre should borrow the idle funds of banks.

Issue with the monetary policy

  • Increase in liquidity not encouraging lending: due to factors such as - 
  • Slowing credit growth can be due to excessive and irrational risk aversion by the borrowers and businesses.
  • Slow lending can also be a rational response by banks that need to preserve capital and liquidity in an uncertain environment.
  • This anomaly is similar to that faced by the United States Federal Reserve in the aftermath of the 2008 financial crisis.
  • Rise in Surplus Reserves: it would be appalling to let approximately ?7 trillion worth of daily liquidity lie unutilized with RBI in a business environment gasping for cash.
  • Failures of measures to encourage banks to lend: such as capping the reverse repo window, could prove counterproductive: 
  • For E.g.-In the midst of the Great Depression in 1936, Federal Reserve's similar action to encourage banks to lend, went counterproductive as banks became more risk-averse. 

Tackling the Arguments against higher deficits

  • Fear of "crowding out" private investment:  
  • This argument does not hold In the current scenario, with private borrowing hobbled by risk aversion and/or lack of demand,
  • Rather government spending during a recession may stimulate the risk appetite of private players, leading to a "crowding in" of investment
  • Fear of Inflation: With inflation being largely dependent on food and energy prices, which are driven by supply-side dynamics, such a linkage fails to establish any relation.
  • Risks to the country's current account
  • Devaluation of the currency: This may precipitate a run on the stock market by foreign investors.
  • This argument misses is that equity investors usually deploy capital in stock markets to benefit from a growing and dynamic economy, not from currency movements
  • Sovereign ratings at risk:
  • But a long, drawn-out recession due to the Centre's reluctance to borrow would eventually result in rating downgrades down the line.

Conclusion: For India's economy to turn the page on the COVID crisis, the government must overcome its despair of the fiscal deficit.

QEP Pocket Notes