The paradox of India’s stimulus response to the covid-19 crisis

Context: The World Economic Outlook report by the international Monetary Fund (IMF) highlights that our  fiscal relief resembles that of advanced rather than emerging economies in its low emphasis on discretionary spending.

Impact of COVID-19 on Indian Economy:

• A permanent loss of output of approximately two years a to the tune of $350-400 billion.
• The widening of fiscal deficit by 4.9% of GDP is broadly comparable to the 5.8% average fiscal expansion among emerging markets.

Issues with Indian fiscal response: India Fiscal Response has been paradoxical and is not in consonance with its emerging market peers.

• Modest discretionary fiscal impulse: at 1.8% of Gross Domestic Product (GDP) and most of the fiscal expansion is likely to come from declining tax collections and other automatic stabilizers.

• In comparison, almost 60% of the fiscal expansion in emerging markets has come from discretionary policy. 

• Focussed on “below the line” liquidity support: The discretionary fiscal impulse of 1.8% of GDP is dwarfed by “below the line” fiscal support amounting to 5.2% of GDP. 

• While the traditional “above the line” measures are accounted for in budgets, “below the line” are usually kept off these ledgers.
• Above the line measures include direct liquidity support while below the line include credit guarantees, payroll support, equity infusion and liquidity schemes.

• Most emerging markets have depended more on “above the line” measures, For E.g. China’s fiscal impulse of 4.6% of GDP is far larger than the 1.3% of GDP in India for “below the line” measures.

Reasons for India’s cautious approach

• Entered the crisis with low fiscal power.
• Wary of a sovereign credit rating downgrade.

• High inflation: which means that a demand stimulus in the midst of a severe supply shock would have added to price pressures. 

• Fiscally conservative nature of the current government.

Conclusion: A rise in precautionary savings across the country will lead to higher demand for safe assets such as government bonds, at least till there is a sustained rise in the private sector.