Stimulus and the need to avoid a double-dip recession

The government sent out mixed signals to markets and investors this week. First came Finance Minister Nirmala Sitharaman’s assurances of fiscal stimulus-2, though she remained zip-lipped about its arrival time. Suffice to say, government expenditure will increase to spur economic activity.

But the ministry also maintained that its market borrowings won’t be revised upwards, implying that additional spending this fiscal is unlikely. Or, chances are, as we see it now, existing allocations could be redirected to aid growth-enhancing projects and as officials indicated, tax collections could pick up pace, allowing departments to spend a bit more.

But this is unconvincing. The budgeted tax revenue target for FY21 at Rs 16.3 lakh crore is already ambitious and based on a projected nominal GDP growth of 10%. However, recent developments and trends confirm that a reduction in tax collections including disinvestment proceeds is inevitable, with various estimates pegging the decline at 10-20%. In fact, revenue reduction, without even considering additional spending, will increase the fiscal deficit, which already hit a seven-year high at 4.6% in FY20.

Moreover, the government’s primary source of funds—household savings including small firms—is sliding amid salary cuts and job losses. This is double whammy for the government as not only income (tax revenue) falls, but also debt sources are drying up.    

Perhaps this is one reason Sitharaman chose not to deviate from the FY21 borrowing plan of Rs 12 lakh crore. Whether this is sufficient for an economy that’s recovering with high-frequency indicators showing promise is unclear. Unlike advanced economies, India’s stimulus had elements of fiscal timidity with government spending at 2-3% of GDP, while economists want at least 5%. Put simply, a fatigued vehicle facing uphill needs force.

One could use an accelerator (tax revenue), but an external push (government spending) gives much-needed thrust. The danger in waiting to intervene until the vehicle reaches a certain height is, it could all come crashing before you know it. For an economy, that phenomenon is called a double-dip recession, which must be avoided at all costs.