(Macroeconomics) India plans stimulus package for sectors worst affected by second wave

India is preparing a stimulus package for sectors worst affected by a deadly coronavirus wave, aiming to support an economy struggling with a slew of localized lockdowns, people familiar with the matter said. The finance ministry is working on proposals to bolster the tourism, aviation and hospitality industries, along with small and medium-sized companies, the people said, asking not to be identified as the deliberations are private. The discussions are at an early stage and no timeline for an announcement has been decided, they said. A finance ministry spokesman declined to comment.

 

The latest wave of Covid-19 infections has made India the global hotspot for the pandemic and has decimated travel since the second wave picked up in March even though Prime Minister Narendra Modi has refused to implement a strict nationwide lockdown. With very high daily cases, many local governments — including India’s most industrialized states — have imposed curbs against the spread of the virus.

 

That’s prompted many economists to cut their forecasts for the financial year that began April 1, as rising unemployment and dwindling savings among consumers dim the chances for double-digit growth. While the International Monetary Fund expects India’s economy to expand 12.5% this year to March— and will be revisiting the forecast in July— the country’s central bank projects 10.5% growth.Modi’s administration doesn’t have enough fiscal room to maneuver even though it received about $14 billion from the Reserve Bank of India as dividend. That will mean, stimulus will most likely be in the form of tax breaks, according to Teresa John, economist at Nirmal Bang Equities Pvt. “The government doesn’t have too much leeway, although the recent RBI dividend provides some cushion,” said John. “The stimulus may be mostly additional guarantees and tax concessions, maybe demand boosting measures once opening up starts. All these may not involve a large government spending.”

 

Flagging growth prospects put the onus on policymakers to support activity, especially once the virus caseload eases. Finance Minister Nirmala Sitharaman, who said last month she’s monitoring the economy in a “very detailed fashion,” has held discussions with economists in recent days about a stimulus package, the people said. “We expect the government to stick to its overall budgeted spending while shifting its expenditure composition more in favor of health services and food subsidies,” said Bloomberg Economics’ Abhishek Gupta.

 

The proposals are being drawn up at time when the rupee has emerged as Asia’s top-performing currency from its worst on signs that India’s virus crisis may be easing after infection numbers hit a record 4,14,118 on May 7 due to localized lockdowns. India’s stock benchmark is also approaching a record-high close reached in February.

 

In April, the finance ministry eased rules for capital expenditure by government departments to try to boost spending in the economy. It also decided to allocate five kilograms of free food to the poor per month as the lockdowns saw millions of migrant laborers flee urban areas and back to their rural homes. But Sitharaman’s hands are restrained given India aims to lower its budget gap to 6.8% of the gross domestic product in the financial year to March 2022, from an estimated 9.5% last year, signaling little legroom for New Delhi to ease purse strings in a significant manner. Pressure also is building on the central bank — which serves as the banking sector regulator -- to ease loan repayment rules, especially for sectors badly hit by this virus wave.

A stimulus package is a form of expansionary fiscal policy, involving an increase in government spending, lower taxes and interest rates to boost the economy. It helps economies recover from a “recessionary gap where real GDP is less than potential GDP and unemployment is higher than natural rate of unemployment” hence working to improve the economic well-being of all stakeholders and to sustain macroeconomic objectives of employment and growth.

In Figure 2, the Indian economy is represented to be at full output level at Yp, where AD3 intersects the AS curve. The lockdown offered sustained downward demand in most industries which results in large-scale unemployment and downward pressure on wages as firms look to reduce their costs of production, especially being the case of tourism and hospitality industries, increasing the prevalence of cyclical unemployment within these sectors. Such widespread unemployment significantly reduces well being, especially relating to income security, quality of life and pursuing potential.As firms' revenue decreases they lower their costs of production and the level of investment also decreases. Lower consumer consumption due to low consumer confidence, quarantine guidelines and high unemployment in turn causes lower firm profits, which results in a falling AD, from AD2 at full potential to AD1, as there is lower consumption and investment in the economy and making AD too weak for firms to produce at Yp, causing the recessionary gap between Yr and Yp.

 

Hence to overcome low employment and economic growth, i.e maintain well being, the government proposed a stimulus package. The main purpose of introducing expansionary fiscal policy is to boost spending in the economy, and support worst hit sectors to shift AD near full capacity at Yp.

 

A stimulus package in the form of tax-breaks would increase after tax-revenue of firms incentivising increased investment spending. An increase in the profit level of businesses is also accompanied by falling unemployment and potentially higher wages. If the tax breaks are on personal income taxes, the real income of consumers increases, combined with demand boosting measures and transfer payments, incentivise increased consumption in the economy. All being components of AD, push AD1 to AD3, at level of output at Ys.

 

The stimulus package also included the handing out of transfer payments to smaller business and worst hit sectors, and spending on merit goods such as food. Smaller businesses and low income groups are more likely to have been hit worse by the effects of the pandemic due to inability to sustain consistent losses and high unemployment of unskilled workers respectively. This as seen in Figure 3, pushes the inequality in income distribution further from the line of equality..

By offering transfer payments and subsidizing merit goods, the government is able to increase the real income of these groups, increasing income security and quality of life and improved well-being. Hence shifting the Lorenz curve after introduction of the stimulus package closer to the line of perfect equality. An increase in government spending by allocating five kilograms of free food to migrant workers and other subsidies, there is a propionate increase in the disposable income of consumers, also pushing GDP near full output.

 

The limited fiscal room of the government may increase the reliance of tax-breaks for the stimulus package.
Personal Tax cuts on consumers may be less effective than government spending in increasing AD, because
part of the increased after tax income may be saved. This is exemplified by low consumer confidence and
dwindling savings, making them feel less secure of their income and wealth, negatively impacting
well-being.

 

Here the stimulus package is able to focus on particular sectors that have been made vulnerable through the pandemic and alleviate the downward market trends. This is particularly useful in reducing the cyclical unemployment seen in the tourism and hospitality industries, the handing out of transfer payments or reduced tax cuts would significantly increase the revenue among these sectors, and the income of those employed within it.

 

Through the crowding out effect, sustained lower tax revenues may increase the government budget deficit, which is presumably already affected by the slew of increased health related spending throughout the pandemic, the government may be forced to borrow, increasing the demand for money which results in higher interest rates, discouraging firms and households from spending the economy pushing down AD. However increasing employment and incomes may increase tax revenue through the progressive taxation system and also decrease spending on unemployment benefits in the worst hit industries.

 

In conclusion, the stimulus package proposed by the Indian government to alleviate the pressure from the pandemic market crunch, would be effective in bridging the recessionary gap, and providing focused help to sectors worse affected and vulnerable groups, achieving economic - well being, but is hindered by limited government fiscal room.

Tragakes, Ellie. Economics for the Ib Diploma Coursebook with Cambridge Elevate Edition. 3rd ed., S.L., Cambridge Univ Press, 2020. Pg 698