The small stimulus and the Modi govt’s fiscal deficit fetish

The divide between the Keynesians and the Chicago school is as intense and often antagonistic as the Sunni-Shia and Catholic-Protestant or Thelakarai-Vadakarai Iyengar divides.

Keynesian economics is a theory that says the government should increase demand to boost growth. Keynesians believe consumer demand is the primary driving force in an economy. As a result, the theory supports the expansionary fiscal policy.

The Chicago School is a neoclassical economic school of thought that originated at the University of Chicago in the 1930s. The main tenets of the Chicago School are that free markets best allocate resources in an economy and that minimal, or even no, government intervention is best for economic prosperity. They abhor fiscal deficits.

The only reason why the actual stimulus package is only Rs 63,000 crore is the obsession with fiscal deficits by Chicago economists such as Raghuram Rajan and his former student, Krishnamurthy Subramaniam, who is the present CEA. They are true representatives of the Washington Consensus to judge countries like India by the size of fiscal deficit. It has been the instrument used to beat countries like India into submission by the ratings agencies such as Moody’s which just downgraded India. We shouldn’t lose too much sleep over it as India is a hardly a borrower abroad and is more of a lender holding $490 billion as reserves fetching near zero rates.

That's why the CEA, when asked about a big stimulus, said: "There are no free lunches!" That's exactly what Milton Friedman said. But they quite happily ignore the biggest deficit-financed economy in the world is the USA. Raghuram Rajan told Rahul Gandhi on his videoconference that a stimulus of Rs 65,000 crore would suffice in the present situation. The Nobel Laureate, Abhijit Vinayak Banerjee, on the other hand suggested a minimum of Rs 10 lakh crore as did Arvind Subramaniam. The USA has just announced a stimulus of over $3.5 trillion or over 15% of its GDP. Modi’s stimulus is a mere 0.3% of India’s GDP.

The Government of India and its BJP and RSS megaphones keep harping on the reduction of fiscal deficit to 3.5% as its great achievement. Now here is some truth for Modi, Sitharaman and the rest of the South and North Block shakhas:

What is 'Fiscal Deficit?'

A fiscal deficit occurs when a government's total expenditure exceeds the revenue that it generates, excluding money from borrowings. Deficit differs from debt, which is an accumulation of yearly deficits.

Many serious economists regard fiscal deficits as a positive economic event. For instance, the great John Maynard Keynes believed that deficits help countries climb out of economic recession. On the other hand, fiscal conservatives feel that governments should avoid deficits in favour of a balanced budget policy.

The fastest growing economies in the world, and now its biggest - USA, China, Japan and most of Western Europe - have the highest debt/GDP ratios. Japan's debt/GDP is over 253% before the latest stimulus of 20% of GDP. China's debt is now over 180% of its GDP. The USA’s debt/GDP is close to 105%. India's debt/GDP ratio is by contrast a modest 62%.

Pump priming the economy by borrowing per se is not bad. It is not putting the debt to good use that is bad. Nations prosper when they use debt for worthwhile capital expenditure with assured returns and social cost benefits. But we in India have borrowed to give it away as subsidies and to hide the high cost of government. To give an analogy, if a family has to make a choice of borrowing money to fund children's education or to support the man's drinking habit, the rational and good choice is clear. The children's education will have a long-term payback, while the booze gives instant gratification to the decision maker. But unfortunately our governments have always been making the wrong choices

I have always believed that a fiscal deficit is not the problem as much as wasting borrowed money is. If borrowed money is used productively and creates growth and prosperity, it must be welcomed. So what we want to hear from the government is not about fiscal deficit targets, but economic growth, value addition, employment and investment targets. Our governments have hopelessly been missing all these targets and have been obsessively focused. It is an idiotic obsession.

But if the regime abhors a stimulus financed by deficit financing, in other words by getting the RBI printing presses go into overdrive, there are other options that can be exercised.

So what can Modi do now to get us out of this quagmire? As it is, he is hamstrung with a weak economic management team with novices as the two key players, the Union Finance Minister and the RBI Governor. Even if he addresses this, where will the money come from?

India has over $480 billion nesting abroad earning ridiculously low interest. Even if a tenth of this is monetized for injection into the national economy, it will mean more than Rs 3.2 lakh crore. At last count, the RBI had about Rs 9.6 lakh crore as reserves. This is money to be used in a financial emergency. We are now in an emergency like we have never encountered or foreseen before. Even a third of this or about Rs 3.2 lakh crore is about five times the present plan.

There are other sources of funds also, but tapping these will entail political courage and sacrifices. Our cumulative government wages and pension bill amounts to about 11.4% of the GDP. After exempting the military and paramilitary, which is mostly under active deployment, we can target 1% of GDP by just cancelling annual leave and LTC, and rolling DA by the last two or three increases.

The government can also sequester a fixed percentage from bank deposits, say 5% of deposits between Rs 10-100 lakh and 15-20% from bigger deposits for tax-free interest bearing bonds in exchange. The ten big private companies alone have cash reserves of over Rs 10 lakh crore.

There is money in the trees, and all it needs is a good shake up to pick the fruits. The pain of the lockdown must not be borne by the poor alone. The government can easily target 5% of GDP or about Rs 10 lakh crore for the recovery fund as an achievable goal. The fiscal deficit goals can wait.

This money can be used to immediately begin a Universal Basic Income scheme, by transferring a sum of Rs 5000 per month into the Jan Dhan accounts for the duration of the financial emergency; fund GST concessions to move the auto and engineering sectors in particular; begin emergency rural reconstruction projects to generate millions of new jobs and get our core infrastructure sectors like steel, cement and transportation moving again.