An Estimation of Required Fiscal Stimulus to Revive the Economy in India

Growth rates of the national
income are likely to be badly affected following the Coronavirus lockdowns in
many countries including India. There would be a rise in unemployment and
poverty unless the government helps in revival of the economy. If the
purchasing power of vast majority of the population comes down, the aggregate
private consumption expenditure would come down drastically. If the aggregate
demand in the market falls, the aggregate supply would also come down in ex-post situation. The expected rate of
profit would fall and the aggregate investment demand would also reduce as
proportion of GDP. Increase in net export would not be able to revive the
economy because Coronavirus led depression is a global phenomenon. Therefore,
the fourth component of GDP i.e. the aggregate government expenditure is the
last resort to revive the aggregate demand in the economy.

To understand the extent to
which the Indian economy is likely to shrink, let us look at the numbers
provided by the central statistical office (CSO) of Govt. of India. According
to the second advanced estimate, the GDP at current prices for the year 2019-20
has been expected to be Rs.204 lakh crore. The private final consumption is
around Rs.123 lakh crore, the government final consumption expenditure is Rs.24
lakh crore, the aggregate investment (including change in stocks and valuables)
is Rs.61.5 lakh crore, export is Rs.38 lakh crore and import is Rs.43.5 lakh
crore. There is a statistical discrepancy of Rs.1 lakh crore. So, the private
consumption is 60.2%, government consumption is 11.8%, investment is 30.3%,
export is 18.7%, import is 21.4% and discrepancy is 0.5% of total GDP of
2019-20 in India.
If we forget seasonal
variation in GDP for simplicity and calculate the GDP for 40 days, it is likely
to be Rs.22.5 lakh crore. There has been some private consumption and
government consumption during the lockdown. Even if we assume the government
consumption to remain unaffected and private consumption expenditure to be one
third during the lockdown period, the total consumption expenditure would be
around Rs.6.5 lakh crore in 40 days. Therefore, the private consumption is
assumed to fall by Rs.9 lakh crore. Addition to the stock of capital or
investment is unlikely to take place during the lockdown. Therefore, the
investment demand would fall by at least Rs.6.75 lakh crore. Let us assume that
the trade deficit remains the same during these 40 days (both export and import
may have come down). Therefore, the net loss in GDP due to lockdown would be in
the tune of Rs.16 lakh crore or so. This is equivalent to 8% of the current GDP
of India.
If we consider data on GDP at
current prices and the combined government expenditure of central and the state
governments during 1990-91 to 2018-19, we see that the government expenditure
elasticity to be 0.96 (by taking logarithms of both the series and running
Cochrane-Orcutt Paris-Winsten bivariate log-linear Regression), given the
structure of Indian economy and the composition of aggregate government
expenditure. The aggregate government expenditure to GDP ratio in 2018-19 has
been estimated to be 28.2% in India. Therefore, the government expenditure
multiplier would be equal to 3.4 i.e. if the government spends Rs.1 lakh crore
extra, the GDP is expected to increase by 3.4 lakh crore. If we assume two
inflation scenarios of 3% and 2% per annum and 6 growth scenarios from 0% to 5%
growth in 2020-21, then the requirement of additional government expenditures
can be worked out as follows.
Additional Government Expenditure Requirements

Note: Author’s calculations based
on the estimation of fiscal multiplier in India.

Clearly, the government has
to spend at least 3% of GDP additionally in order to achieve 0% growth with 2%
inflation. If we consider the expected inflation rate to be 3%, then the
additional expenditure requirement would be 2.25% of GDP or Rs.6.5 lakh crore
(scenario 1) in order to ensure non-negative growth in the country. To achieve 5%
growth in 2020-21, under the 3% inflation assumption, the government has to
spend 4.7% of GDP or Rs.9.4 lakh crore extra (scenario 6). If the inflation
rate comes down to 2% in 2020-21, the extra expenditure requirement would be
4.4% of GDP or Rs.8.8 lakh crore (scenario 12). If the government announces 5% of
GDP (i.e. Rs.10 lakh crore) worth of stimulus package, it should be possible to
achieve 9% nominal growth (either 5% growth and 4% inflation or 6% growth under
3% inflation) in India in 2020-21. It is important to mention here that the
developed countries have already announced packages worth of 21% of GDP in
Japan, 11% of GDP in the US, 9.9% in Australia, 8.4% in Canada, 6.5% in Brazil
and so on and so forth (see chart).
There would definitely be a revenue
shortfall due to lockdown and economic depression. Therefore, if the government
goes for necessary expansionary fiscal policy as mentioned above to revive the
economy, the combined fiscal deficit would rise by 4-5% of GDP in the current
fiscal year. Whether the commercial banks would be willing to lend the government
that much amount of money would really depend on the credit-deposit ratio of
the banks. After lockdown, the demand for credit would come down due to reduction
in investment demand and the deposits would also come down because of lower
income of people at the aggregate level. The rest of the money can be borrowed
from the central bank (RBI) to finance the additional fiscal deficit. The
central bank may wish to lend 4-5% of GDP amount of money to the government at
a discounted rate to combat the coronavirus challenge instead of just tinkering
with the reserve ratios and the repo rates. The RBI is sitting on a foreign
exchange reserve worth of Rs.36.7 lakh crore (18% of GDP, 480 Billion US$) as
on 24th April 2020. Monetisation in the tune of 5% of GDP or Rs.10
lakh crore is perfectly possible for the RBI at this hour to revive the growth
for maintaining the aggregate level of employment in the economy. There is no
possibility of demand-pulled inflation under a situation of demand deflation –
the international oil price has also hit the historic low because of the
pandemic. Our total import bill of 6 months is less than 11% of GDP. Even if
there is a risk of some capital flight, the government can always borrow 5% of
GDP from the RBI. Higher fiscal deficit may lower India’s rating but, lower
growth also would do the same. Higher level of unemployment would cause misery
in the country and lower the future investment and growth rate and revenue
earning even further. We would be entering into a vicious cycle if the
government does not give the fiscal boost now.
The government should spend
this additional money not only on health-related expenditures but also to
compensate for peoples’ income loss due to 40-days long lockdown. It must go
for cash transfer particularly to the poorer section of population. The
compensation should be given at the state-wise minimum wage rates for
agricultural workers in the rural areas (Rs.350 per day) and that of industrial
workers in the urban areas (Rs.450 per day). This is essential not only for supporting
the poor for their survival but, for keeping their purchasing power intact so
that the aggregate demand can be maintained in the economy after lockdown gets
over. The small and medium scale enterprises (SMEs) also should be supported to
restart their business in full-fledged manner. The MGNREGS should be expanded
to the urban areas also and the wage rate should be made equal to the minimum
wage rates of agricultural labourers and industrial workers in the scheme. The
education expenditure should be gradually increased from 3% to at least 5% of
GDP. The combined government health expenditure as proportion of GDP in India
is one of the lowest in the whole world (less than 1% of GDP excluding water
supply and sanitation). The government also must try to increase this ratio to
3% of GDP as soon as possible. Since, these are primarily state subjects, more
money should be given in the hands of the state governments. If the government
does not increase its expenditure at least by 3% of GDP this year, we are
likely to face a negative growth rate in India in the economic year 2020-21.
This prediction is based on the assumption of 40 days long lockdown; the
numbers would be higher in the present context of partial extension of it upto
the 17th May.

The author is Assistant Professor at CESP, JNU, New Delhi