Anticipating the Unintended #56: The Emotional Atyaachaar of Aatmanirbharta

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

India Policy Watch: What Next For The Economy?

Insights on burning policy issues in India

— Raghu Sanjaylal Jaitley

In the third week of May, the government rolled out a ₹20 trillion economic package to mitigate the risks of COVID-19 pandemic. The package was a mix of fiscal and monetary stimulus for the short-term with a few important structural reforms included whose impact could play out in the long-term. The critics of package felt it was anaemic on measures to stimulate demand and didn’t do enough to restore consumer confidence to spend.

The government had a different view. They argued the supply-side measures will save firms from going under, protect jobs and, eventually, lead to demand revival. Since then the COVID-19 case count has kept its exponential march on and we have had multiple localised lockdowns in most of our urban centres. The virus has spread to most large states and lifestyles and household consumption patterns have undergone changes that impact the Indian consumption story.  Ten weeks later, it is useful to ask if we have a better sense of how things are unfolding.

The Package That Wasn’t A Package

We had raised three issues across multiple editions of this newsletter about the ‘aatmanirbhar’ economic package:

  1. The government’s decision to focus on supply-side interventions could have several reasons. One, it didn’t want to blow a hole through the fiscal deficit targets which could lead to ratings downgrades and collateral damages. Since the pandemic was a global phenomenon, we felt the government was overestimating the ratings agencies and their impact. Two, we were almost sure the government would come out with a fiscal relief and stimulus package before Q2 (ending September) as the extent of demand destruction becomes evident. Three, a strong state is a prerequisite for a targeted and efficient implementation of fiscal stimulus measures. We felt the supply side emphasis was a tacit acknowledgement by the state that it lacks confidence in its administrative machinery.
  2. We were worried about how we track the success of the measures announced by the government. More specifically, we were interested in the central claim that these measures will revive demand indirectly. Our concern was in the absence of an agreed-upon metrics to track, we will be treated to ‘cherry-picking’ of data to rival peak season in the Anatolian orchards.
  3. We felt ‘aatmanirbhar’ was too open-ended a term to interpret. We cautioned, despite the assurances offered by the PM and the FM, it would devolve into import substitution and a protective trade regime across non-strategic goods which would be a net negative for India.

In this section of the newsletter, we will focus on the first two issues highlighted above. The third issue is discussed in the next section.

Supply Side Can’t Do All The Heavy Lifting

The government has continued with its stand on supply-side measures being adequate to tackle the crisis. The credit facilities that were offered to MSMEs and other larger corporates haven’t been fully utilised. They aren’t keen on increasing their debt until they are sure of the demand picking up. What has instead happened is a classic case of unintended consequences.

The credit facilities have been used by two kinds of firms. One, those who are already in a strong financial position and have used this to accumulate ‘dry powder’ for future at low rates. Two, on the other extreme, by firms who were in a bad shape even before the pandemic and are using its cover to prolong their lives. The spectre of zombie firms that plagued the Japanese economy for the last three decades is quite real. The deserving ‘middle’ who would have been helped by a demand stimulus has been squeezed. The role of the market in efficient allocation of resources that leads to creative destruction has been compromised.

The recent statements by the CEA have been perplexing. In one of his recent interviews, he made three points that helped to understand the government’s thinking now. One, the government is seeing green shoots of demand recovery with the data from GST to road toll collections being shown as evidence. Senior officials in finance ministry claimed we will see a V-shaped recovery in the coming months. Two, the CEA claimed a fiscal stimulus will work best when customer confidence is back. In his view, this will happen only after a vaccine is ready. So, it is best to launch the fiscal stimulus then. Now is the wrong time since consumers will park the stimulus money in the banks instead of spending them. Three, the CEA brought up the Indian policy response during the 2008-09 Global Financial Crisis (GFC) and how it led to high inflation and a currency crisis in 2012. The government wants to avoid a repeat.

There’s a lot that doesn’t add up in this narrative. First, the points on green shoots of recovery don’t reconcile with the government waiting for consumer sentiments to revive only after a vaccine is developed. If we are already seeing green shoots and the finance ministry is talking about a V-shaped recovery, why wait till a vaccine is developed to deliver a fiscal stimulus? The right time should be now. Only one of these two statements can be correct.

Consumption is as much about sentiment as it is about actually having the money to buy. A stimulus is, therefore, a signal by the government that can improve consumer sentiment. Waiting till the vaccine is developed is a wrong signal and will continue to dampen sentiments.

Also, we aren’t sure if the right lessons of our policy response to the GFC are being learnt. It wasn’t about the timing of our response then which was quite appropriate. It was how long we continued with a loose fiscal policy that hurt us. In The Lost Decade (2008-18)Puja Mehra chronicles how Pranab Mukherjee, who was the FM then, continued with the stimulus way longer than it was needed:

“Over the next three years, Mukherjee, the dirigiste finance minister, hiked allocations for social-sector spends, ignoring the revenue position, the expanding fiscal deficit and the economy’s capacity for absorbing the fund releases productively. The budget for 2008–09 presented in February 2008, months ahead of Lehman’s collapse, had projected a fiscal deficit of 2.5 per cent and a revenue deficit of 1 per cent. A year later, presenting the Interim Budget in February 2009, Mukherjee told a shocked Lok Sabha that the fiscal deficit had ballooned to 6 per cent of GDP and the revenue deficit had widened to 4.4 per cent. The actuals came out later in line with these projections. The fiscal stimulus overdose, Chidambaram conceded in 2013, overheated the economy and stoked inflation. The effects played out over time.

Arvind Virmani, chief economic adviser till 2009-end, prepared and submitted a road map for ending the fiscal stimulus before leaving the post to assume charge as India’s representative to the IMF in Washington. It lay about unattended, gathering dust, ignored or forgotten. ‘When a recovery is evident, reverse the stimulus,’ this exit strategy proposed. Virmani’s second recommendation was, ‘Resume reforms then for removing bottlenecks to sustain the growth recovery.’

…..Even after the rebound in the economy, the stimulus was allowed to go on. The overstimulation soon set inflation on fire.”

Read the full edition here.

Disclaimer: Views expressed on Anticipating the Unintended are those of the authors’ and do not represent Takshashila Institution’s recommendations.