9 minute read 30 May 2020
COVID-19 impact on emerging economies

Can fiscal and monetary stimuli help the Indian economy recover from COVID-19?

D. K. Srivastava
By D. K. Srivastava

EY India Chief Policy Advisor

A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

9 minute read 30 May 2020
Related topics Tax COVID-19
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The COVID-19 pandemic has dealt a severe blow to an already stressed economy.

In FY21, the Indian economy nearly lost the full month of April and a relatively large part of May 2020 due to the nationwide hard lockdown. Purchasing Managers' Index (PMI) for manufacturing and services contracted to unprecedented levels of 27.4 and 5.4 respectively in April 2020, while growth in bank credit remained subdued at 6.7% in the fortnight ending 24 April 2020.  In March 2020, Index of Industrial Production (IIP) contracted by (-)16.7%, its lowest level in the 2011-12 base series. Contraction in power consumption increased considerably to (-) 24.7% in April 2020 reflecting a sharp fall in domestic demand. At (-) 60.3% in April 2020, contraction in exports was the sharpest since 1991 reflecting global and domestic supply disruptions. With respect to automobile sales, information from major players in the sector indicates zero domestic sales in April 2020[1].

India’s growth under challenge: distinguishing acute ailment from chronic

Recent assessments by various analysts have significantly lowered India’s growth prospects for FY21. In a release dated 8 May 2020[2], Nomura projected a contraction of (-) 5.2% for India. On 17 May 2020[3], Goldman Sachs also projected a contraction of (-) 5.0%. Available growth forecasts vary from (-) 5.2% to 4%, showing a wide range of 9.2% points. This only indicates significant uncertainty in the assessment of the economic impact of COVID-19 on the Indian economy by domestic and international observers. The actual outcome is likely to depend on (a) the pace at which the Indian economy opens up, (b) the magnitude and composition of fiscal stimulus over and above the budgeted expenditures, (c) the impact of the monetary stimulus, and (d) the effectiveness of expenditure reprioritization by the central and state governments as compared to their respective budget estimates.

The Indian economy suffers from a chronic investment slowdown on which an acute breakdown of economic activities has been overlaid due to the lockdown. This has led to the possibility of both GDP and tax revenues slipping into a contraction in FY21 perhaps for the first time in India’s post-independence history if we consider these growth rates on an annual basis. On a trend basis, real GDP growth has been falling consistently from a peak of 6.9% in 2010-11 to the currently estimated trend level of 6.0% in FY20. The actual growth in FY20 has turned out to be 4.2%, that is, 1.8% points below the trend growth.

In the case of tax revenues, the trend growth rate had peaked at 16.8% in FY08. Since then the tax revenue growth on trend basis has been falling. By FY20, it is estimated to be about 5.8% while actual tax revenue growth has contracted by (-) 3.4%. This has significantly squeezed the available fiscal space.

Strategizing stimulus: Monetary and fiscal

Four major sets of stimulus packages have been announced since the end of March 2020 till date. Two of these sets pertained to fiscal initiatives and two to monetary. We may describe these as follows:

  1. Monetary stimulus 1: On 27 March 2020, the Reserve Bank of India (RBI) lowered the repo rate to a historic low of 4.4%, well below 4.75% level in April 2009, to which it was brought down in response to the 2008-09 crisis. The CRR was also reduced by 100 basis points to 3.0%. On 17 April 2020, the reverse repo rate was lowered by 25 basis points to 3.75%. Several liquidity enhancing measures were announced on 27 March 2020, 17 April 2020 and 27 April 2020. These included Targeted Long-Term Repos Operations (TLTROs) and special refinance facility for infusing liquidity into National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI) and National Housing Bank (NHB) for on-lending/refinancing purposes.
  2. Fiscal stimulus 1: On 26 March 2020, the government announced an economic relief package of INR 1.7 lakh crores under the PM Garib Kalyan Yojana. The stimulus included insurance cover for doctors, paramedics and healthcare workers, free food grains provision and direct cash transfers through DBT for disadvantaged sections of the population. The demand side support in this package is estimated at INR 62,082 crores.
  3. Fiscal stimulus 2: From 13 May 2020 to 17 May 2020, the Finance Minister announced a stimulus package in five tranches which together amounted to INR 11.02 lakh crores with an additional burden on the FY21 budget of INR 1.2 lakh crores. The magnitude of first tranche was INR 5.94 lakh crores and it was largely focused on the MSME sector that is facing the maximum brunt of COVID-19. The second tranche which involved an estimated benefit of INR 3.1 lakh crores, focused on the poorer sections of the society including small and marginal farmers. It included a mix of short-term relief provisions and a scheme for affordable rental housing for migrant workers and urban poor. The third tranche containing an additional benefit of INR 1.5 lakh crores, focused on long overdue supply-side agriculture reforms. Considering the fourth and the fifth tranches together, the estimated benefit amounted to INR 48,100 crores. The fourth tranche focused largely on medium-term efficiency improving industrial reforms. Two notable features of the fifth tranche were a) enhancement of the budgeted MGNREGA allocation of INR 61,500 crores in FY21 by INR 40,000 crores and b) relaxation in the borrowing limit of states from 3% to 5% of their respective GSDPs subject to certain conditions.
  4. Monetary stimulus 2: On 22 May 2020, the RBI announced another reduction in the repo rate by 40 basis points, bringing it down to a historical low of 4%. Along with it, the other relevant rates such as the reverse repo rate, the bank rate and the MSF rate were also lowered by a similar margin. This should enable both the consumers and investors to borrow at a lower cost thereby facilitating an increase in both consumption and investment demand. According to information given by the RBI, the reduction in the weighted average lending rate on fresh rupee loans has been 114 basis points during February 2019 to March 2020. In the same period, the reduction in the policy rate was 210 basis points, indicating that the transmission rate stands at about 54.3%.

The stimulus package covering monetary stimulus 1, fiscal stimuli 1 and 2 amount to INR 20,97,053 crores, equivalent to 9.8% of estimated FY21 GDP. It can be decomposed into three components namely (a) amounts already provided for in the FY21 budget (5% of total package), (b) amounts that are to be additionally provided for (9.7% of total package), and (c) amounts pertaining to RBI, banks, NBFCs and other institutions (85.3% of total package).

The stimulus package covering monetary stimulus 1, fiscal stimuli 1 and 2 amount to INR 20,97,053 crores, equivalent to 9.8% of estimated FY21 GDP. It can be decomposed into three components namely (a) amounts already provided for in the FY21 budget (5% of total package), (b) amounts that are to be additionally provided for (9.7% of total package), and (c) amounts pertaining to RBI, banks, NBFCs and other institutions (85.3% of total package).

Deciphering overall stimulus package

Why fiscal stimulus is so constrained?

According to present estimates, centre’s fiscal deficit in FY21 may be estimated at 7.1% if the budgeted level of expenditures is to be protected and the additionality in the fiscal stimulus is also to be provided for. The state governments have been allowed to enhance their borrowing. Their consolidated borrowing may be estimated at 5.0% of GDP if they avail of the enhanced limit fully. The central and state public sector undertakings may require another 3.5% of GDP. Together, this gives a public sector borrowing requirement (PSBR) of about 15.6% of GDP. The estimated total resources available for government borrowing at 9.5% of GDP in FY21 may fall well short of this. This gap of 6% points may have to be met by monetization of debt as well as additional borrowing from abroad. To the extent an imbalance continues, the borrowing by PSUs may have to be reduced and/or state governments may not borrow to the full extent of their enhanced limit of 5% of GDP. In this situation, a downgrading in India’s credit ratings is quite likely. On 01 June 2020 Moody’s downgraded India’s credit rating to the lowest investment grade, while maintaining a negative outlook. In all likelihood, the cost of borrowing would increase. States have already experienced a sharp increase in their cost of borrowing as the yield of 10-year state government bonds auctioned on 7 April 2020 rose by nearly 100 basis points as compared to that which prevailed a month before. However, the enhanced liquidity resulting from the current and earlier monetary measures may keep the borrowing cost for the central and state governments from rising up inordinately.

Conclusion

The Indian economy has been on a downslide in recent years though various growth-supporting initiatives were introduced by the government in its earlier term. Despite these initiatives, the erosion of growth could not be arrested. The reason for this has been a steady fall in private investment which could not be undone by a corresponding increase in public investment particularly that in government’s capital expenditure. In fact, center’s non-defence capital expenditure has been languishing at low levels of 1.0% to 1.3% of GDP during FY16 to FY21 (BE). The typical reform, relief and stimulus packages have been based on insurance schemes (PM Fasal Bima Yojana, PM Suraksha Bima Yojana, PM Jeevan Jyoti Bima Yojana, and Ayushman Bharat) and credit guarantee programs. Their success depends on a number of behavioral parameters in which entrepreneurial decisions of farmers, MSME entities, managers of NBFCs and banks etc. are involved. Because of these factors, the impact of these schemes gets considerably diluted. Growth calls for a straight-forward push to demand particularly investment demand. To kickstart this, it is government’s capital expenditure that should play a pivotal role. By augmenting this, private investment would also increase through the multiplier effects. Government’s relief packages are meant to provide temporary relief and help in kickstarting the economy. Given that the present crisis is a health crisis, emphasis may be placed on building up health infrastructure which is also part of the National Infrastructure Pipeline (NIP). Other components of NIP should also be taken up in the earlier years of NIP’s five-year period.

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Summary

Growth calls for a straight-forward push to demand, particularly investment demand. To kickstart this, it is the government’s capital expenditure that should play a pivotal role.

About this article

D. K. Srivastava
By D. K. Srivastava

EY India Chief Policy Advisor

A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

Related topics Tax COVID-19
Upvote