Not spending will also raise deficits as GDP will slow

The government has so far provided a fiscal stimulus of about `4 lakh crore, across three tranches of its Atmanirbhar package, which works out to a shade under 2% of GDP. While one doesn’t expect India to be making the kind of trillion-dollar spends made by large economies like the US, the amounts are way below the infusion levels of 2.5% provided by peer economies or those rated Baa3, the lowest investment grade by Moody’s.

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More pertinently, it is grossly inadequate to kickstart growth, which contracted 24% y-o-y in Q1FY21 and is expected to de-grow both in Q2 and Q3. Indeed, the government appears to be agonising a bit too much over the deficit because, going by the trend so far, government expenditure for the year may actually turn out to be contractionary. That is very worrying because it is now evident states will need to cut back substantially on capital expenditure this year and perhaps even on revenue expenditure.

The Centre’s reluctance to spend appears to stem from the anxiety that the debt-GDP ratio, currently hovering at a little over 70%, could shoot up to the 90% level. A bloated fisc, the government probably fears, might prompt the ratings agencies to downgrade India—which, in turn, could stymie foreign capital flows.

To be sure, a consolidated fisc of close to 15% and an elevated debt-GDP ratio are never desirable. But, the economy has suffered a massive shock and, unless resuscitated quickly, might turn comatose. In fact ,in mid-October, following the announcement of the second round of stimulus measures that involved a budgetary support of just 0.2% GDP, Moody’s had observed the small scale of the stimulus reflected limited budgetary firepower to support the economy and was, in fact, credit negative.

Other economists too have pointed out that a small and ineffective stimulus might well wreck the recovery, resulting in bigger deficits in the coming years. As Dr Pronab Sen pointed out on Friday, it is important to understand that a lower deficit today could result in growth sliding or picking up very slowly, which then would result in a high deficit persisting for a longer period. Instead, a bigger deficit today could boost the economy, resulting in faster growth and smaller deficits in the future.

The government, Sen believes, should not view the deficit from a one-year perspective but rather from a long-run perspective, say over three-four years.

While a step-wise approach to injecting stimulus might sound rational, it could be ineffective. Indeed, unless the highly vulnerable small and mid-sized businesses are given immediate relief, a large number of them might go bankrupt, and the shutdowns would inevitably result in huge losses of capital and thousands of jobs.

More critically, it could hurt banks and other lenders, causing a loss of capital and making them even more risk-averse. A calibrated stimulus, based on an assessment of the strength of the recovery, might not deliver the desired outcomes. Saving ammunition for later might seem like a good idea, but will not work and will cause more damage.