The FRBM Act needs amendment
In the latest instalment of ‘Mann ki baat’ delivered on April 25, the Prime Minister exhorted the people of India to treat the present moment as “yudh” or a war against the virus SARS-COV-2. However, the government’s approach to the economy, under lockdown for over five weeks, has been anything but warlike. An economy is an emergent phenomenon, its path altering when it is buffeted by shocks. This calls for a creative response by the public authority when one occurs. Globally, we are facing a situation that is not just abnormal but, failing a providential reversal, is set to damage our prospects as societies. Public authorities in almost all democracies have recognised this threat and unleashed unprecedented economic force. By contrast in India economic policy appears paralysed, without a significant economic package announced yet.
The lockdown implemented by the government is tantamount to an economic shock. As there is no production no income is being earned by the vast majority of Indians. This would be cause enough for concern even if the loss is confined to a single period. But an economy exists in time. Today’s national income drives tomorrow’s expenditure which determines income the day after. So the lockdown may be expected to have consequences that extend well into the future. It is unlikely that income will bounce back to some pre-determined level once it is lifted. In fact, there is the possibility that we will continue to slide. Economic policy in a democracy is expected to address this possibility. Recent world history has shown that there are varieties of responses even among democracies when it comes to assuming responsibility for the economy. Consider the responses of the United States and by governments in the Euro area, respectively, to the global financial crisis in the last decade. An aggressive fiscal stimulus in the former meant that the United States recovered briskly while reluctant activism by the conservative European Central Bank and equally conservative governments has meant that a whole continent has fared poorly by comparison. This contrast suggests that Europe’s misery is of its own making; in the words of the Dutch macroeconomist Willem Buiter “recessions are a choice”. It implies that it is within the reach of economic policy to determine the state of the economy by preventing a collapse of aggregate demand. Could it be that our own future in India after the lockdown is lifted will be closer to the experience of Europe rather than the United States after the global financial crisis?
Of course, so long as a lockdown persists, the problem is not just one of aggregate demand, for it is the supply side that is impacted first. But as wages not paid today lower tomorrow’s expenditure a supply restriction could soon end up as a demand recession. Of the two arms of macroeconomic policy, namely monetary and fiscal, it is the latter that has greater potential once demand slows. This feature, which is established in theory, is particularly relevant under the circumstances India finds itself in today. The economy has been slowing for three years since 2017-18 following the demonetisation in late 2016. There is an explanation for this. In a slowing economy private investors tend to be sceptical of the growth of profits, and are likely to contract investment. Now growth slows further, impacting investment in the next period, and so on.
Only government can counteract slowing private investment. The Great Depression is reckoned to have lasted for a decade from 1929, ended only by the Second World War. War had meant greater public expenditure, which restored economic activity. Nowhere was this more in evidence than in the United States which was launched into a period of extraordinary prosperity for three decades. It is important for us in India to learn from this period in world history and to tailor our economic policy accordingly.
A hurdle placed in the path of renewal of economic activity post-lockdown is the Fiscal Responsibility and Budgetary Management Act of 2003. It ties expansionary economic policy to a fiscal deficit limit of 3 percent of the gross domestic product. This when the fiscal deficit of the centre was already at 3.8 percent in 2019-20. The government can of course amend it allow for an emergency, such as one we face at present. Not amending the Act is one of the sources of the paralysis in economic policy in India today. It ensures that the government cannot expand its spending to battle the consequences of the spread of the coronavirus SARS-COV-2. Greater expenditure is required in four buckets, first for relief, next for the medical response, then for an aggregate demand stimulus and finally for ramping up the public health infrastructure.
It is difficult to fathom the non-interventionist macroeconomic policy stance of the Government of India, one bordering on irresponsibility though wrapped in the rhetoric of fiscal rectitude. Never before has it been as true that “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” (J.M. Keynes)