Sunday, February 15, 2009

Interim budget fiscal stimulus prescriptions

The Interim Budget, or Vote on Account, to be presented by the Government of India on Monday assumes significance, far in execess of its regular importance. It is expected to be the forum for the Government to announce the third round of its fiscal stimulus. The fact that the government has had to announce a third round within the space of three months, is itself an indicator of the uncertainty surrounding policy making, understable given the times. The expectations that have gathered in the lead up to the announcement is an issue of concern, since the markets are certain to be disappointed with anything that the Government delivers tomorrow.

The industry and lobby groups have been calling for tax and duty cuts to stave off a bigger downturn or even a recession. I am strongly inclined to believe that such measures will have limited impact on aggregate demand (AD), the fundamental rationale for any stimulus spending. They are most likely to end up as corporate welfare subsidies, which boost the bottom-lines, with limited impact on AD. Such measures announced so far have already foregone over Rs 50,000 Cr in direct and indirect tax revenues. Given the heavily constrained fiscal space, it is imperative that all stimulus spending delivers the biggest bang for the buck.

Further, it may not be realistic to expect private investments and private sector to pull the economy out of trouble. Even in developed economies like the US, the private sector has virtually shut off its investment tap. This reluctance is likely to be more pronounced in developing economies like India. In the circumstances, there is no substitute for government spending to revive the economy.

As even recent examples show, duty cuts rarely ever gets passed on to the consumer by way of lower prices. Even if they get passed on, the proportion that gets passed on will be disproportionately low, implying a multiplier benefit of less than unity. Tax cuts for the industry are even less stimulating. It rests on the questionable assumption that increased profits will incentivize businesses to make more investments. Such hopes are clearly misplaced given the deep uncertainty about future economic prospects prevailing in the environment.

Export support by way of lowering duties and some guarantees are an even less effective option. Exports are hit not because the prices are high, but because the export market is shrnking. Even a 20% depreciation in rupee has failed to make any dent on the declining exports. At a time when the global demand is shrinking it is plain wrong to assume that government assistance to lower the cost of production will boost exports. In fact, such support is also likely to end up as transfer of wealth from the exporter to the importer. Further, many such measures are also likely to come up against the WTO norms on unfair trade practices, especially when protectionist sentiment is gaining ground across the world.

In this context, here is my list of fiscal policy prescriptions for the Government

1. Expand NREGS in both scope and quantity. NREGS is the classic Keynesian stimulus, the ideal vehicle to putting money in the hands of those most affected by and vulnerable to the crisis and most likely to spend all the money they receive. Its multiplier on the local economy and the boost on AD is likely to be very high.

It may also be appropriate to expand the scope of NREGS, atleast temporarily, to cover community works with a material component, in addition to manual earth work. This will help bridge the long-felt gaps in community assets like primary school and health sub-centre buildings, community halls, village roads and drains, check-dams and other minor irrigation structures, etc. Such works have a three-fold benefit - create tangible community assets, stimulate the private sector, and provide empoyment to people - whereas manual earth work only provides the last. And such schemes are likely to be politically populist too.

2. Expand rural and urban weaker section housing programs in a big way. Housing construction has linkages with more than 200 other sectors and has one of the largest multipliers on the economy. Instead of using government grants or subsidies, such schemes should seek to leverage bank loans and private capital. And instead of the usual ownership approach, the government should consider alternative strategies like vouchers.

3. Expand the allocations for flagship programs like JNNURM, PMGSY, SSA, ARWS, RGGVY etc. And here too, prioritize to take up repairs and maintenance, and re-starting incomplete, delayed and post-poned investment projects. Streamline and fast-track sanctioning process and expedite fund releases. The Government can even consider temporarily increasing the Government of India share of project cost, for atleast a few sanctions, so as to relieve the burden on cash-strapped state and local governments.

4. Since the economic weakness is likely to persist for atleast a couple of years, the government should also consider giving a renewed push for major infrastructure projects, both by direct funding and by public private participation. The NHAI roads, power projects, ports and airports, and urban infrastructure works can all be given a push with suitably tailored guarantees to facilitate financial closure. The India Infrastructure Company Ltd set up to mop up funds for infrastructure investments should get its act together swiftly to raise money and then disburse the loans.

5. With bulging foodgrain stocks, the government can afford to temporarily increase the allocations under the Public Distribution System (PDS), as a one time measure for a period of six months. This can be delivered to the present PDS beneficiaries, but through more targetted approaches like food stamps or bundled along with the NREGS wages or welfare pensions or to SHG members in urban centers. This will deliver one of the largest returns, given that it woill benefit those who are most likely to spend all of the money saved, and also since it would reduce the susbtantial carrying costs incurred by the FCI and others on these foodstocks.

6. Private investment can be incentivized by offering a temporary, one year intially, tax break for investments in certain specific sectors. Credit enhancement support and even credit guarantees can be offered, for a limited intial period, on borrowings for new projects in certain sectors. All such incentives should come in the form of tax credits, to be reimbursed back on production of the required validating documents.

7. The Government should also consider temporary increases in the Central share of few successful (say, as appraised by the Planning Commission) welfare programs of the state governments. This can be expanded to make one time capital injections into a few of the successful state initiatives on health care, skill development, education, medical insurance, employment generation etc, like the Arogya Sri and Abhaya Hastam Programs in Andhra Pradesh and Chiranjeevi Yojana in Gujrat. This would serve as an incentive to these states, besides setting the stage for their expansion to other states. The selection of these programs can be done in an objective manner by way of quick independent evaluations, many of which are already available. The approaching elections makes this a politically diffcult option to implement without considerable pork and wastage.

8. Private consumption carries considerable potential in pulling the economy out of the trough. Government can encourage consumption by offering temporary credit incentives (lowering provisioning requirements on loans made to these sectors etc) to banks lending for hire purchase on consumer durables like electronics, automobiles, homes etc, and ensure that banks pass on the benefits to the consumers. Such incentives should be for a limited period of say, three months, so as to force consumers out into the market. This is far more effective way of stimulating demand than by cutting taxes and duties, which tend to only add to the company bottom line.

9. If the government still has fiscal space, it can consider making one time direct cash handouts to the existing welfare pensioners and expedite the release of second instalment of the Pay Commission handouts.

10. Finally, a fiercely contested general election, with massive spending on campaigning, is more welcome now than ever and can be one of the most efficient fiscal stimulus. It will provide a much needed filip to the local economy with large multiplier effects. It will also be effective in leveraging private money, albeit of the "black" variety, to boost AD.

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