It’s a contrarian thing to say but the recession in the West and an economic slowdown at home has made Indian consumers richer. You pay lower taxes on income and prices of select products and services are lower today than they would have been if the downswing hadn’t hit the economy in 2008. At the broader industry level, overall stimulus of Rs 2,18,000 crore, or $45 billion, has kept consumer and industrial demand buoyed.
So far so good. But policy mandarins are seized of concerns that if the United Progressive Alliance coalition government continues with its stimulus packages over the next few months, it could hurt the Indian economy in the long run. The Hobson’s choice before them is: reflate or deflate?
Until now, India has been largely insulated from the global financial crisis, thanks to New Delhi’s stimulus packages. To begin with, Finance Minister Pranab Mukherjee left more money in the hands of taxpayers with an aim to encourage spending and boost consumption. He scrapped a 10 per cent surcharge on income tax (that had increased the peak basic income tax rate to 33 per cent even before specific levies to finance education) and increased certain tax-free allowances. At the same time, he cut service tax and excise and customs duties to lower the costs of inputs. If that was not all, Mukherjee raised government expenditure in infrastructure and rural India through four fiscal packages.
The keeper of all things monetary in the country, the Reserve Bank of India, too, steadily pruned benchmark interest rates and tweaked banking ratios that determined the cost of borrowing for consumers and the industry. Result: interest rates are today lower than what they were 18 months ago.
There is no doubt that this multi-pronged approach helped cushion the economy from the impact of the global crisis. Industrial production, for instance, rose 9.1 per cent in September, beating analyst expectations for the fourth consecutive month. And some measures such as plan spending on development are, as our columnist Kirit Parikh argues on page 34, anyway overdue reforms and should be kept in place.
Still, the big question remains: How much longer should the economy be stimulated? Just like too much of coal fed into a steam-driven rail engine can result in its boilers bursting its rivets, continued stimulants to the economy could well start hurting it.
Look at the signals. Already, inflation, measured by the new monthly Wholesale Price Index (WPI) for October, has inched up to 1.3 per cent from the year-ago period versus 0.5 per cent year-on-year in September. The RBI has raised its inflation target to 6.5 per cent for fiscal 2010 from the earlier 5 per cent. There are growing doubts whether the government’s fiscal deficit, pegged at 6.8 per cent of Gross Domestic Product (GDP) in the Union Budget for this financial year, will be contained at that level. Even if it was, New Delhi would still have to borrow a record Rs 3,98,000 crore, or nearly Rs 1,100 crore a day, in fiscal 2010—some 29 per cent more than the previous year.
Although the RBI has raised more than eight of the ten rupees that the government needs this fiscal year, a crowding out of private borrowers (don’t forget that recovery means industry will start getting hungrier for funds than it had been in the past two years) and a resulting increase in interest rates could sooner than later become reality. In its latest credit policy, the central bank has signalled “the first phase of exit” from monetary accommodation with a 1 percentage point increase in the statutory liquidity ratio (SLR, a measure of mandatory bank investments in government bonds) to 25 per cent of a bank’s deposits. It also reversed—partially or fully—some liquidity accommodation introduced through various instruments last year for banks, mutual funds and housing finance companies.
That itself will not affect the liquidity in the system given that Indian banks’ SLR investments are already at 27.6 per cent, yet there is little mistaking RBI message: Be ready for a tighter money policy. In other words, end of downturn also means end to booster dose of goodies.