What Past Crises Taught Us

Context: The result of the handling of Past economic crises underlines the importance of expanding capital expenditure (capex) rather than Revenue Expenditure (revex) to come out of a crisis.

Arguments against increasing revex instead of capex during a crisis: Increasing revex during Global Financial Crisis (GFC) of 2008 resulted in macroeconomic crisis in 2013 -

• Decreased gross fixed capital formation: After Global Financial Crisis (GFC), the government expanded revex, which resulted in a decrease of gross fixed capital formation from 35.8% in 2007 to 31.3% in 2013 of the Gross Domestic Product.
• High fiscal deficit (FD) without asset creation: E.g. from 2.5% of GDP in 2007, India’s FD remained above 4.5% for each year during 2008-13, peaking at 6.5% in 2009 after the farm-loan waiver.
• Deterioration of Current Account Deficit (CAD): from 1% of GDP in 2006 to 4.8% in 2012.
• High currency depreciation: 56% currency depreciation during 2011 to 2013 time period.
• High Inflation: Consumer Price Index (CPI) inflation increased sharply from 6.4% in 2007 to 12.2% in 2013 and increase in non-food inflation from almost 0 in 2009 to 9% in 2011.

Arguments in favour of increasing capex during a crisis: done during the Asian financial crisis (AFC) of 1998.

• More value addition to the economy: According to a study conducted in 2015, the multiplier effect from Rs 1 of capex, is 2.4-6.5 times the revex multiplier.
• Result in crowding in effect: on the other hand, revex will result in crowding out effect.
  • Increase in capex during AFC leads to Golden Quadrilateral being built and crowded in private investment in the economy.
• Increase in gross fixed capital formation: from 25.4% in 1998 to 29.9% in 2001.
• No significant rise in inflation: as compared to the revex; E.g. Inflation declined from 13.2% in 1998 to 4.7% in1999 and 2000 and remained below 4% till 2004.
• Improving CAD: From –1.4% of GDP in 1997-98 to –0.8% in 2000-01.
• Improving exports: increased from 10.7% of GDP in 1997 to 17.9% by 2004.
• Low currency depreciation: the currency depreciated only by 14% by January 1999 against the level in 1997-98.

India’s COVID response: Inspired by the success in dealing with the AFC crisis

• Focused on enhancing demand and aggregate supply: through strengthening the manufacturing sector to enhance productivity and aggregate supply while creating organized sector jobs to increase aggregate demand.
• Focused on preventing high food inflation: through the farm reforms and planned investment in farm infrastructure.
• Try to reap the gains from economies of scale: through measures like change in the Micro, Small and Medium Enterprises (MSME) definitions.
• Reforms in factor markets: To reduce the supply-side frictions that hobble the economy.