Can the fiscal stimulus be withdrawn?

The recent signs of buoyancy in economic growth and the possibility of a quick return to 9% plus growth rates, coupled with an unsutainable fiscal deficit, has naturally prompted calls for withdrawing the fiscal stimulus measures implemented by Government of India to boost aggregate demand during the slowdown last year. There is also a mounting chorus of opinion to exit from the loose monetary policies in the face of rising inflation.

The main components of the Government of India's fiscal stimulus measures were cuts in indirect taxes, farm loan waivers, Pay Commission wage arrear payments, increased spending on NREGA, rural and other infrastructure, and concessions to various infrastructure sectors. I have blogged earlier about the debate surrounding the extent of stimulus impact these measures may have had on the economy.

Of these stimulus measures, the government can exit only from the tax cuts and the spending measures. However, the NREGA and infrastructure spending measures and concessions cannot be withdrawn because they would have been initiated even without the economic slowdown. This leaves rolling back the indirect tax cuts as the only meaningful stimulus exit.

The central government had cut the Cenvat rate from 14% to 10% in December 2008 and then to 8% in the interim budget of February 2009. Service taxes were cut from 12% to 10% in February 2009. These indirect tax cuts translate into an estimated fall in excise and customs collections of Rs 28,000 crore.

As I have already blogged, many of these tax cuts were never passed on to the consumers by way of lower prices but went into increasing the profitability of businesses and adding to corporate welfare. However, I am inclined to believe that on the upward side, any tax increases are likely to get transmitted to the consumers by way of higher prices. And at a time when inflation looms large, any tax pass-through by way of higher prices could end up adding to the inflationary pressures.

In contrast, exiting the almost Rs 6,00,000 Cr monetary easing (by way of cuts in reserve requirements and special liquidity facilties, including quantitative easing' by way of purchases of bonds from banks in return for freshly minted money, since September 2008) is easier. The exit has already been initiated with the hundred basis point hike in SLR in October and the decision to stop QE purchases since October.