The fiscal stimulus that was announced just after I wrote my last post turned out to be smaller than some in the media had predicted, at least in terms of direct spending. However, there were several other measures that increase the effect of the total package. Increased spending in the plan is Rs. 200 billion, or $ 4 billion. The infrastructure finance piece is Rs. 100 billion, or $2 billion, or only a fifth of what had been predicted earlier in the Times of India. But there is also a cut in the central value-added tax rate, credits and tax breaks for exporters, and some low interest loans for housing and for small and medium enterprises. The total impact on the government fiscal deficit could be about $6 billion, which will add something like 0.6 percentage points to the deficit-GDP ratio. This does not count the infrastructure finance part, which I think is being structured to be off-budget, like the recent oil subsidies. The latter have been very bad, but may be alleviated now by the fall in the oil price. All in all, the fiscal stimulus seems pretty substantial, and given the lags and other problems in implementation (lack of institutional capacity, in particular), I don’t agree with calls for further increased spending, as reported in the Financial Times. (By the way, I don’t know where that FT article got its claim that the government had promised $60 billion total of additional spending. That seems way too high to be right.)
I am not alone in being a bit skeptical of how much the fiscal stimulus can accomplish. The same Ila Patnaik piece also is skeptical of monetary policy’s efficacy in India. I am not so sure of that. The channel of transmission may not be as smooth as in countries that have less financial repression, but I think lower interest rates would still help a lot. As I have said, I think nominal interest rates are too high given how low projected growth is (now estimates are coming in below 6 percent for 2009-10) and how low WPI inflation is over the last couple of months. In this respect, I am shocked by the fact that India’s chief statistician, Pronob Sen, is talking up the danger of inflation. He’s basing his worries on what might happen to the CPI (still rising after the WPI inflation came down), which is inconsistent when the WPI was being used to argue for tightening when the CPI was lower. The argument as reported is backward looking and subjective, and totally neglects what is happening to demand as the global economy continues to slip. The RBI should NOT listen to him!
I am sympathetic to arguments for further economic reform, by Ila Patnaik and by Ajay Shah, particularly with respect to the domestic financial sector, and the inflow of foreign capital. I would add, however, that it would be useful to identify measures that are politically feasible, or low-risk, so that they can be pushed through quickly. I am not sure what exactly those would be, but incrementalism seems to be standard operating procedure in Indian policy making. I’d also like to see some more carefully targeted tax incentives – I realize this counts as fiscal policy (and the deficit is an issue), but does not suffer from the implementation problems of increasing spending. In particular, I think that expanding the favorable tax treatment for various forms of investment, R&D and for venture capital could have large payoffs. I recall that a recent central government budget had a very convoluted and restrictive plan for incentives for venture capital in specific sectors. Making such schemes much broader based and simpler to enforce could be beneficial. I see this as a financial sector reform in a sense. I think the conceptual point is that targeting can be based on encouraging new firms of any form, and not trying to pick winners in terms of sectors. Essentially, the government needs to be thinking about supporting the “creative” part of creative destruction. The “destruction” part is already happening very fast. Anything that supports private investment seems to be a good idea at this time, and I’d like to see the government keep hammering away at the decline in economic activity. It was encouraging to have fiscal and monetary responses within two weeks of the carnage in Mumbai, but more needs to be done.