An Unfounded fear of the Fisc will Worsen our Economy

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.