Business Today

When and how to withdraw stimulus

Stimulus measures that are in the nature of reforms should continue, other measures may be gradually withdrawn as domestic demand grows, industry recovers, tax collection becomes buoyant and exports growth recovers.

Kirit S. Parikh        Print Edition: December 13, 2009

Signs of economic recovery are visible. I had predicted a growth rate exceeding 7 per cent for 2009-10 with the various stimuli given. Despite the poor monsoon and the lower growth rate of agriculture, we are almost there. However, concern for inflation is increasing. The question then is how long should the stimulus measures continue? What is a good strategy for phasing them out?

The stimuli were directed to increase domestic demand through increased spending on plan schemes and reducing tax rates besides supporting exports through cheaper credit, lower duty rates and increased outlay for promotion schemes. There was a thrust on improving credit availability to industry and for infrastructure by increasing liquidity of the financial system.

When should a particular stimulus measure be withdrawn depends on the purpose of the measure and indicators of its success. Some of the measures are in the nature of reforms that are permanent and there is no reason to withdraw them. For example, measures to direct credit to the Micro, Small & Medium Enterprises (MSME) sector should be continued. Measures to stimulate domestic demand such as accelerated expenditure on plan schemes that lead to more inclusive development should continue in any case.

Should the tax cuts be withdrawn? This should depend on how good is the tax revenue collection. One should also look at how well industry is doing, what is the growth of industry due to increase in demand or build up of depleted inventories. If industrial growth is demand driven and if it is threatening to lead to demand pull inflation, then it is time to reverse the tax cuts or raise interest rates. However, one should be cautious here as a little bit of inflation may be preferable to choking the recovery prematurely.

When exactly the borrowing limit of the states should be reduced depends on the buoyancy of tax revenues. When revenue collections suggest that states would be able to keep their expenditure at reasonable levels to maintain their development rates then it would be the time to reduce states' borrowing limit.

The measures to stimulate export may be required for some more time. Exports have not seen the recovery that one would like. This is because around two-thirds of our exports go to USA, Europe and Japan. Our exports growth depends on the recovery of these economies. The stimulus that we have given increases the competitiveness of our exports vis-à-vis other exporters. By reducing the price of our exports, some additional demand may be created. However, countries facing domestic unemployment may restrict imports by various means. In an environment of shrinking global trade, our goal here should be to maintain our export share.

To summarize, stimulus measures that are in the nature of reforms should continue, other measures may be gradually withdrawn as domestic demand grows, industry recovers, tax collection becomes buoyant and exports growth recovers. The desired level of government expenditure should be maintained without increasing fiscal deficit. This can be done by rationalising government expenditure and raising income through some disinvestment.

Kirit S. Parikh is former member, Planning Commission

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