Bend with the wind

Context:  In the light of uncertain times amidst pandemic, the rationale for public spending is strengthened by the recent spending spree by the Brazilian Government through income support to households and firms.

The rationale for Government Expenditure:

• Source of reducing poverty and inequality: in the form of income support to the firms and the households.

• Necessity due to Pandemic: the Government allowed the spending cap to be breached with large pandemic- related additional expenditure, including generous income support. This has helped:

• Although Brazil’s COVID-19 infection rate was about the same as in India in the second-quarter GDP growth collapsed by only 33.5%, half of that in India.
• Unlike typical Emerging Market crises, the pandemic is not an instance of a financial crisis turning into an economic shock because of damaged balance sheets.

• Impact on private demand: Public spending helped to offset some of the collapses in private demand in Brazil, but in India, it added to the decline.
• Upgraded growth projections: continued income support, analysts have upgraded growth in Brazil while further downgrading it in India.

The rationale for Capping of Government Expenditure: In 2016, Brazil passed a constitutional amendment capping the government expenditure to 20% of the Gross Domestic Product (GDP)

• Dependency of expenditure on the Boom-Bust Cycle: Government expenditure can be constrained due to the end of the boom phase.

• For, E.g. With the end of the commodity boom in 2013, Brazil’s growth faltered, and funding programmes strained macroeconomic management, widened the fiscal deficit, and raised public debt. 

• Existence of Structural Deficiencies:

• For, E.g. economic recession worsened in Brazil due to corruption scandals, turned into a political crisis, inflation, unemployment, and the fiscal deficit all jumped to double-digits.

•  It will raise the overall spending to above 28% of GDP and together with the revenue shortfall
• It will increase Brazil’s fiscal deficit from 6% of GDP in 2019 to an astounding 17% of GDP this year.

• Act as a Transparent fiscal anchor: The spending cap sets a transparent fiscal anchor that restored macroeconomic stability and in doing so helped to bring down inflation.

• For, E.g. Brazil’s inflation declined from over 10% in 2016 to around 2.5% and opened the space for policy interest rates to be cut from above 14% to 2% at present.

Lessons for India:  Bend with the wind

• Provide Income Support: Rather debating over demand management, the focus should be towards the supply side, i.e. income support that can compensate for the collapse in private demand.

• Transparent fiscal anchor: The spending cap sets a transparent fiscal anchor that restored macroeconomic stability and in doing so helped to bring down inflation.