Role of Fiscal Policy in India during Recent Downturn

By- Saumya Singh, Contributing Editor

The ineradicable intrinsic to the Indian Constitution is the trinity of ‘equality, liberty and fraternity’ enshrined in the preamble, which is the wind in the sails of justice. The justice envisaged is social, economic and political, a helm of the popular democracy. Denial of social and economic justice is enthrallment and shoving our political democracy into an oblivion state through stupefaction and squandering. Innumerable measures have been undertaken by the sovereign to deeply entrench and disseminate the popular notions of social and economic justice in the centrestage of socioeconomic milieu, reinvigorating political democracy by circumventing and relegating economic slumps and recessions. One among such is ‘fiscal policy’, the demand side of economic policy, which deals with taxation and expenditure undergone by the Government. It has a twofold objective of aggrandizing the growth performance of the economy and cinching social justice to the people.

The contour of Fiscal Policy is circumscribed by the prism of optimization of financial resources for the attainment of rapid economic growth. It delineates taxing system, Government expenditure, foreign debt management, surplus management, budget deficits and, investment and disinvestment strategies. It is a mechanism through which country’s economy is predisposed by maintaining employment, stabilizing aggregate demand, dampening inflation and deflation and resurrection from economic recession. Its foremost objective is mobilization of stagnant resources lying ruthless in public and private sector, which is effectuated by revamping interest rates, tax rates and escalating public expenditure. Government expenditure through planned investments in public sector boosts employment, provides incentives for consumer spending, induces investment from private sector, curtails inequality in the accumulation of wealth and facilitates balance of payment.

Fiscal Policy: Ingeminated from Keynesian Theory

The genesis of Fiscal Policy lies in Keynesian Economic theory propounded by British Mathematician and Economist, John Maynard Keynes. He asserted that aggregate demand comprising household and consumer spending, business investments, government expenditure and net exports, influences the performance and expansion of economy. Floundering economy and recessions are the denouement of inadequate consumption spending and excessive accretion of savings, which dilapidates the aggregate demand.[1] This ramification can be remedied by the Government through fiscal deficit or fiscal surplus. When there is conspicuous exuberant of investments and proliferate spending, the Government can run into fiscal surplus by expanding the tax rates and receding its expenditure. When the economy is marked by antithetical situation, the Government can run into fiscal deficit by accelerating its expenditure and minifying tax rates. The erstwhile is Contractionary Fiscal Policy and the latter is Expansionary Fiscal Policy.[2]

The other tool for influencing economic condition is Monetary policy, the other demand-side of economic policy, which deals with the supply of money in the economy and the rate of interest. It is managed by the Central Bank, while the erstwhile is managed by the executive and legislative wings of the Government. It relegates inflation and influence liquidity and consumption by altering the interest rates and providing incentives to the individuals to lend money and induce circulation in the economy. Its objective is eradicating unemployment, avoiding dwindled Gross Domestic Product (hereinafter ‘GDP’), stabilizing inflation and foreign exchange rates. Through monetary expansion or monetary contraction, the bank can incentivize the individuals to restrict savings and promote spending or vice-versa, respectively. Monetary policy enhances economic activity whereas Fiscal Policy addresses total spending or total composition of spending or both.[3] The combined effect of Fiscal and Monetary Policy is a means towards the end of rapid economic growth.

India’s Eclecticism Towards Economic Theories

India follows eclecticism due to its non-adherence to any specific economic theory whether Classical or Marxian or Keynesian. The kernel of the Classical Theory lays in the self-regulation of economy, which is propounded by Scottish Economist, Adam Smith. He marked economy as susceptible to efflux demand and supply where its resilient disposition assists in attaining the natural GDP or aggregate demand.[4] The elasticity in the market system adjusts economy to its original standard. Classical economists dwell upon Say’s law[5] and the elasticity of wages, prices and interest rates. They espoused laissez-faire approach or minimal Government intervention in the market milieu.[6] It was assailed by Marxian Theory, propounded by German Philosopher and Economist, Karl Marx. He expounded that increment in unemployment and not surplus labor drives wages to the subsistence threshold. He denounced Capitalism because it enhances surplus labor and reinforces exploitation. He favoured Government intervention which facilitates social justice by utilitarianism.[7] He espoused the ‘Labour theory of Value’ viz the value of a commodity depends upon the average number of labor hours required to manufacture it.[8] Then, came the Keynesian Economics which depends upon aggregate demand, consumption and spending. He espoused that ultimate economic growth can be obtained by influencing aggregate demand through modifying tax rates and Government expenditure. The theory was propounded during the Great depression wherein, critical blows and setbacks were given to the Classical Theory. He was an apostle of Countercyclical Fiscal Theory, wherein Government runs into fiscal or budget deficit to reinvigorate the floundering economy. He assailed the notion of exuberant savings, which hampers the mobilization of money in the economy.[9]

The Pandemic and The Stimulus Package of India

The fiscal deficit target for the current FY was 3.8 % of the GDP which was set after using the escape clause mentioned in the Fiscal Responsibility and Budget Management Act, 2003.[10] The COVID-19 pandemic has opened our conscience to various vulnerabilities one among them is economic stress and slowdown. The Government is already running into fiscal deficits and the Corona outbreak has accentuated it. It is also suggested that India should liberalize its Fiscal Policy for 1-2 years[11] in order to combat the current crisis or it will rise up to 7.9 % of GDP in FY 21.[12] In order to stabilize the dwindled economy, the Government has announced an economic stimulus package of Twenty Lakh Crores INR, which is 10 % of the GDP[13], with envision of stimulating aggregate demand and resuscitation from economic depression. This action of Government is reinforcement of stimulus package founded in Keynesian Economic Theory, which sanctions the excessive spending by the Government to stabilize the economic downturn.

A stimulus package comprises economic and financial measures which Government undertakes to revitalize and reinvigorate the economic slowdown.[14] The Government encourages employment and proliferate spending to render the economic recession nugatory by running into fiscal or budget deficit. Lower tax and interest rates, tax rebates and other innumerable incentives are proffered by the Government to aggrandize consumer spending, aggregate demand and, private investments. The outcome can be achieved through monetary stimulus or fiscal stimulus. In the erstwhile, interest rates are reduced to zero thereby, providing impetus for people to borrow. The denouement of proliferate borrowing is augmentation in the wide circulation of money, which effectuates exuberant spending and enhances exporting, and is propitious to stabilize the elasticity of economy. In the latter, tax rates are reduced thereafter, people have adequate money for disposal, which ultimately escalates spending and facilitates economic growth.

The current stimulus package offered by the Government focuses on land, labor, liquidity and, laws as a part of Atmanirbhar Bharat Abhiyan.[15] The Union Finance Minister, Nirmala Sitharaman averred in a Press Conference as to how the stimulus package would be optimized. 5.94 Lakh Crores, 3.1 Lakh Crores, 1.5 Lakh Crores and, 48 Thousand Crores were announced in different instances for funding Farm gate infrastructure, formalization of Micro Food Enterprises, collateral free loans for Small businesses, auction of 500 mining blocks, increment in FDI investment limit in defence sector from 49 % to 74 %, 6 airports for auction, entitlement of  private sector  for the utilization of ISRO facilities, private participation to be allowed in Defence productions, power, outer space, bauxite and coal mining sectors, encashment to various farmer families, National Social Assistance Programme beneficiaries, Women holding Jan Dhan Account, Building and Construction Workers, insurance of Healthcare workers, allotment to MNREGA scheme, borrowing limit of state to be increased from 3-5 % of GDP for the year 2020-2021. In addition to the abovementioned, it also focuses on education, business, decriminalization of certain offences of the Companies Act, non-inclusion of debt due to corona in default and increment in the minimum threshold for initiating insolvency from 1 Lakh to 1 Crore.[16]

The Indian economy is running into fiscal deficits from past 12-15 months and major setback to be thrusted by the pandemic is no exception. The government is taking recourse to the Keynesian theory but its expediency is skeptical. Keynesian Theory is a mute spectator of ‘stagflation’ as it has always conceived the inverse relation between inflation and unemployment, which is derisory. ‘Stagflation’ is a condition wherein, inflation and unemployment soar with descending supply. Is it indubitable that CORONA can map the road to Stagflation in India? Will Keynesian Theory comport the prevalent milieu and resuscitate the dilapidating Indian economy? Is the Government accounting jugglery and voodoo economy? Will the Indian economy be able to sustain exorbitant interest rates because of the colossal fiscal deficit and excessive build-up of debt?

[1] Sarwat Jahan et al, ‘What is Keynesian Economics?’, (May 19, 2020,  1159 hrs).

[2] Jim Chappelow, ‘Fiscal Policy’, (May 19, 2020, 1153 hrs).

[3] Troy Segal, ‘Monetary Policy v. Fiscal Policy: What’s the difference?’, (May 18, 2020, 1533 hrs).

[4] Julie Young, ‘Classical Economics’, (May 19, 2020, 1202 hrs).

[5] Economy is always capable of reverting back to its normal state. It always equate the real GDP with the income needed to purchase it.

[6] CliffsNotes, ‘The Classical Theory’, (May 19, 2020, 1200 hrs).

[7] Daniel Liberto, ‘Marxian Economics’, (May 19, 2020, 1209 hrs).

[8] Mick Brooks, ‘An Introduction to Marx’s Labour Theory of Value’, (May 19, 2020, 1212 hrs).

[9] Jim Chappelow, ‘Keynesian Economics’, (May 19, 2020, 1214 hrs).

[10] Act 39 of 2003.

[11] Nachiket Kelkar, ‘India must relax fiscal policy for 1-2 years: Economist Nageswaran’, (May 18, 2020, 1710 hrs).

[12] The Economic Times, ‘Fiscal Deficit to balloon 7.9% in FY 21: Report’, (May 18, 2020, 1725hrs).

[13] The Economic Times, ‘Dalal Street, here’s what in it for you in Narendra Modi’s Rs 20 lakh crore doleouts’, (May 19, 2020, 1217 hrs).

[14] Adam Hayes, ‘Stimulus Package’, (May 19, 2020, 1220 hrs).

[15] The Economic Times, ‘Summing up Modi’s COVID stimulus: Big takeaways from the big COVID package’, (May 18, 2020, 2046 hrs).

[16] The Times of India, ‘Nirmala Sitharaman announces last tranche of economic package’, (May 19, 2020, 1222 hrs).

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