Stimulus indeed, but for whom? Barring a few crumbs thrown to the consumers through service tax cut, everything in the latest stimulus package is calculated to shore up the bottom line of corporate houses on the eve of the forthcoming elections. One would have to be really blind not to see the obvious linkage. Like the earlier packages, this one too will only swell the coffers of select beneficiaries at home and abroad, rather than create additional income for the people who really need it.

Every official data on the economy only serves to confirm what people already know: India’s elephantine economy is tiring out. In the third quarter (October-December 2008), the GDP crawled at a poor 5.3 per cent, a far cry from 7.9 percent and 7.6 percent in the first two quarters. The manufacturing output declined by 0.2 percent and agricultural growth slowed down to 2.2 percent despite a good monsoon. The healthy growth in some services is illusory, brought about largely by an increase in salaries of government servants. More money, in this case, does not mean additional or better services. The rupee sank to its lowest level against the dollar (Rs. 52.20) before edging up, and the stock market has slumped in reflection of the bleak outlook on the economy.

The latest stimulus package announced by stand-in finance minister Pranab Mukherjee has to be assessed against this grim reality. With inflation down to 3 percent, the RBI has chipped in with a 0.5 percent cut in repo rate and reverse repo rate (the rates at which it lends to and borrows from banks, respectively). But will all these measures pull the economy out of the morass in which it finds itself?

While presenting the interim budget, Mr. Mukherjee had refrained from making any tax-related announcements, rightly pleading that it would be inappropriate to do so in an interim budget. It took the government exactly eight days to cast norms of propriety (never a top priority in any case) aside and announce a series of tax cuts and reliefs aggregating Rs. 30,000 crores.

In terms of democratic practice, tax rate changes are now part of the interim budget exercise. Future governments will undoubtedly use this as a precedent to justify many more changes in the tax rates through interim budgets. In his interim budget in 2004, Mr. Jaswant Singh stopped at reducing the import duty on passenger baggage. Now, changes in excise and service tax rates have been introduced through the interim budget. The next interim budget may introduce some direct tax rate changes.

The latest stimulus, which could be the last one from the UPA Government before the general elections, includes reduction of the Cenvat rate to 8 percent from the existing 10 per cent. The changes made in excise duty rates as part of the stimulus packages are now being extended beyond 31 March 2009. Service tax rate on taxable services have been brought down from 12 percent to 10 percent.

“It is another stimulus to the economy. I hope it will have beneficial impact. This will also help boost exports. The tax concessions would entail revenue sacrifice of Rs 30,000 crore (for a financial year),” Mr. Mukherjee told reporters after the Lok Sabha passed the Interim Budget 2009.
In reality, barring a few crumbs thrown to consumers through service tax cut, everything in the stimulus package is calculated to shore up the bottom line of Corporate houses on the eve of the forthcoming elections. One would have to be really blind not to see the obvious linkage. Like the earlier packages, this one too will only swell the coffers of select beneficiaries at home and abroad, rather than create additional income for people who really need it.  

Whether or not it achieves anything else, the new stimulus will certainly send the fiscal deficit through the roof. The fiscal deficit for the current fiscal year has shot up to 6 percent of GDP from 2.5 percent as budgeted for. Add to this 1.5 percent for off-budget items like dues to oil and fertilizer companies, another 3.5 percent for State government deficits and India’s consolidated fiscal deficit will be 11 percent this fiscal, as high as in the crisis year of 1991. In 2009-10, it may shoot up to 12 percent, taking into account the impact of the revenue foregone and additional plan expenditure promised. In fact, revenue slippages, very likely during a downturn, could make it worse.

The government borrowing programme will get larger. In 2008-09, government borrowing was 1.8 times what was targetted and in 2009-10, it will be 2.54 times the target for 2008-09. Around Rs. 45,000 crores of required borrowing in 2008-09 has still been left uncovered following the interim Budget. And now there are the indirect tax cuts.

This has put the Reserve Bank in a quandary. If it allows government to borrow such huge amounts, interest rates will shoot up, crowding our private investment and all hopes of an early recovery. If it decides to monetize the deficit, fully or partly, it will be fuelling inflation.

The bleak picture of government finances has already started taking its toll. The rating agency Standard and Poor’s (S&P) has downgraded India’s credit outlook to ‘negative’ from ‘stable’. India’s long-term credit rating has been retained at ‘--BBB’, which is the lowest investment grade, but the risk of further downgrading remains.
 

It would be churlish to argue that, with government bonds being bought mostly by public sector banks, a sovereign downgrade does not matter. Such downgrade raises borrowing costs for Indian companies also, for no fault of their own. The outstanding foreign debt of India Inc. is estimated at $166 billion and a one percent increase in borrowing cost pushes up its interest costs by Rs. 8300 crores annually.

Foreign investment, already reduced to a trickle by the global economic crisis, will take even longer to resume. The double digit fiscal deficit and uncertainties regarding the post-election government and its policies may well enlarge the macro-economic risk in the minds of lenders and investors.

Nevertheless, if all the stimulus programmes in their combined effect invigorate the economy, the risk of a future debt pile-up would be worth taking. But will they? One has doubts.

Cuts in excise duty and service tax are aimed at lowering the cost of production. The assumption here is that producers will reduce prices, which will stimulate demand and revive the economy. If past experience is any guide, producers typically prefer to pocket such relief rather than pass it on, unless other reasons compel them. In any case, the full benefit is never passed onto the consumer. Moreover, in times like these, consumers also prefer to save money for worse days rather than splash it on more or costlier goods.

Viewed in this light, the latest largesse from the government looks more like doles for corporate houses on the eve of the elections, rather than a sincere attempt to kick-start the economy.

The same goes for interest rates. Lower cost of capital, we are told, will promote investment and perk up the economy. Again the expectation is not borne out by experience. Japan had interest rates close to zero for several years, but remained mired in recession. The US is discovering the same lesson now. Businessmen are not willing to borrow even at low rates, because they are not sure that any fresh investment will pay for itself. Moreover, even if they are willing to borrow, banks and other lenders may be too risk-averse to lend.

Then there is the larger issue of efficiency and accountability of government expenditure. According to recent reports of the Comptroller and Auditor General (CAG), over Rs. 51,000 crores allotted for anti-poverty schemes (rural jobs, literacy, mid-day meals, child welfare, urban renewal, drinking water in villages, and so on) in the 2007-08 Budget just disappeared into bank accounts of NGOs, autonomous bodies and district authorities. The Government has no clue as to how this money was spent, if at all, by these organizations. Cynics would say that that was the original purpose of the schemes: to fill pockets of jholawallahs and apne-wallahs.

Essentially, recession is a psychological problem which cannot be solved only by monetary or fiscal tools. It would be far better for the government to start placing large orders with companies for steel, cement, power generators and so on. This will shore up business confidence, which will percolate to their employees who are the consumers, and revive the economy. But this government has very different ideas and, more important, priorities.

There will be little action on the policy front at least till the general elections are over and the new government is in place. Even after that, much would depend on the nature and priorities of the new government. In other words, till the new Government makes its first major policy announcement in the form of full-fledged budget for 2009-10, the economy may continue to drift. As the full impact of the global meltdown is likely to be felt in 2009-10, it may prove to be worse than 2008-09 in terms of economic and financial performance.

The author is Executive Editor, Corporate India, and lives in Mumbai