Why has India funked a big fiscal stimulus to stimulate the economy? The answer must be mainly political. The Prime Minister’s Office is clearly the driving force behind India’s fiscal conservatism. Most likely, the PMO fears that a fiscal spending spree will send inflation soaring to 9%, the level at which voters have historically rebelled against the ruling party. That worry is not unreasonable but is overblown.
The latest stimulus package announced by finance minister Nirmala Sitharaman consists of central spending of Rs 49,695 crore, plus hopes that state governments and consumers will spend more, adding up to a stimulus of Rs 1,00,000 crore. Even this inflated figure is just 0.5% of GDP.
By contrast, the US is considering an additional stimulus taking the total to over 30% of GDP. Japan, after two stimulus packages of nearly 40% of GDP (not all of this was fiscal), is crafting a third stimulus of maybe 20% of GDP.
By contrast, all of India’s fiscal stimuli add up to barely 2% of GDP. India cannot be as adventurous as the US or Japan, which have hard currencies and government borrowing rates close to zero. The BJP may fear that a big fiscal deficit will crush the rupee and cause an exodus of foreign portfolio investors. In fact, India has a big balance of payments surplus today. Indian interest rates have fallen but 10-year gilts still yield 6%.
The lockdowns have crushed revenue collection. The combined central and state deficits could cross 12% of GDP even as GDP falls 10%. The debt/GDP ratio could touch 90%, which would be terrible in normal times.
But these are not normal times. Hence countries across the world have run humungous deficits, while central banks have flooded markets with cash and slashed interest rates. Despite this record fiscal and monetary stimulus, inflation has mostly been low or zero, even in developing countries like Indonesia (1.4%), Thailand (minus 0.7%) and China (2.4%).
India is among the few exceptions. Consumer inflation in September hit 7.4%, well above the RBI’s target of 2-6%. The main culprit was food inflation, but even core inflation was 5.6%. Vegetable prices spiked after the crop was hit by excessive rain, but clearly other factors are at work. The biggest is that lockdowns have severely disrupted industry, transport, and other services, causing upward price pressures. Lower oil prices have not been passed on to consumers but mopped up by the government through higher taxes. And a depreciating rupee has raised import prices.
In coming months, the easing of lockdowns and stabilisation of the rupee should tame supply bottlenecks, and inflation too. The problem is certainly not excessive demand. Covid has made people over-cautious about spending, which is why the latest stimulus obliges consumers and state governments to spend their extra allotment by March 31 or forfeit it.
The best way to raise demand and end supply bottlenecks would be to lift all lockdowns. Absent bottlenecks, a big fiscal stimulus should increase demand without causing big inflation. Nobody expects a fiscal stimulus of 30% of GDP as in the USA or Japan. But why not double India’s fiscal stimulus to 4-5% of GDP?
Collapsing domestic demand is reflected in falling imports, notably of gold. This, plus a big inflow of foreign portfolio investment, has meant a flood of dollars into India. To prevent this from appreciating the exchange rate and making the rupee uncompetitive, the RBI has bought dollars massively, increasing its forex reserves by over 25%.
Economist Neelkanth Mishra of Credit Suisse has argued persuasively that the dollar flood should be used to finance a bigger fiscal deficit rather than go into ever-rising forex reserves. This will stimulate economic growth without inflation.
In sum, BJP fears that a big fiscal push will cause high inflation and lose elections are highly exaggerated. Indeed, a successful stimulus could increase incomes and jobs and yield more votes in upcoming elections.
In Bihar, the Opposition parties — Congress and RJD — performed so poorly when in power that even Nitish Kumar’s lacklustre performance in his third term should ensure an easy victory in November. In 2021, the states going to the polls are Kerala, West Bengal, Tamil Nadu & Puducherry, and Assam. The BJP looks very unlikely to win the first four and certain to win the fourth, regardless of inflation.
In the 2019 general election, BJP won 18 seats in West Bengal, not far short of the Trinamool Congress’ 22 seats. But BJP almost always fares far worse in state elections than general elections. Beating Mamata Banerjee will require a revolution in vote shares. The clinching factor will not be fiscal deficits or inflation.
