The Great Indian bailout...

The Great Indian bailout!

Prime minister Manmohan Singh's diagnosis of, and remedy for, the economic slowdown isn't too off-the-mark. I think we are in a typical Keynesian situation where there is a lack of demand private sector demand is very weak but, strong government demand, both for social services and for physical infrastructure, will provide the essential stabilisers that our country needs at a time like this, he had declared on October 25. Yet, the antidote has few buyers.

It's easy to see why. Even as Singh spoke, Finance Minister P. Chidambaram was preparing to beseech Parliament for funds over and above budgetary allocations to pay salaries and bills. He wanted and got additional sums that add up to a third of the total Budget he had piloted through Parliament only in May this year. Government spending has overshot Chidambaram's estimates mainly on subsidies and rural wage programmes (see Budget Busters). Such largesse to the aam aadmi has dominated the UPA government's spending agenda since it took office in May 2004. So far this year, the Centre has pumped in more than Rs 1,340,000 crore into rural development (about half of resident Indians' bank deposits), inflating its fiscal deficit by 26 per cent over its last year's level. It can be taken for granted that the fiscal deficit this year will miss the target, says Suresh Tendulkar, Chairman of the Economic Advisory Council to the Prime Minister.

The global economic crisis is the Government's excuse for overshooting the deficit target. So what if our deficit settles at 3.2 per cent instead of 3 per cent? If the target is breached by a few decimal points, so be it, because there is a global financial crisis and we are suffering the ripple effects of this crisis, Chidambaram told the Rajya Sabha on October 29. He employed this year's Nobel winner for economics, Paul Krugman's tip, this is no time to talk about the deficit , in the Government's defence, following a scathing attack from former Finance Minister Yashwant Sinha on the demand for supplementary funds.
The Finance Minister's defence will be credible if he can turn the deficit into an antidote for the current economic downturn. Investment, the key driver of economic growth, is slowing down after an average rate of growth of 18 per cent in the past five years due to which the Reserve Bank of India (RBI) has forecast GDP growth at 7.5-8 per cent this year. The volatile cost and non-availability of credit is further slowing down projects. In such a scenario, public expenditure the one that boosts productive spending will pump prime the economy.

Injecting moneySix major heads of government spending and their likely impact.
Rs 25,000 crore on Farm Loans Waiver Has offset the dampening effect on rural consumption by cushioning agricultural incomes with waivers amounting to Rs 72,000 crore
Rs 38,863 crore on Fertiliser Subsidies Has protected farm incomes; the huge fuel subsidies, which the government doesn't pay in cash, are protecting urban, rural and middle class incomes and consumption
Rs 1,274,474 crore on the NREGS Has boosted rural incomes and consumption and is creating demand for construction materials. Total funds available with states as on October 31 were: Rs 1,976,9890 crore; of which states have spent 65% or Rs 1,274,473 crore
Including: 70% on wages: Rs 898,216 crore for 7.8 million households or 12.5 million people 4% on semi-skilled and skilled wages: Rs 45,359 crore 23% on materials: Rs 287,615 crore 3% on administration: Rs 43,283 crore
Rs 29,579 crore on Rural Development Has boosted village incomes and fuelled demand for construction materials
Rs 3,862 crore on Road Infrastructure Is generating demand for construction materials.

Government spending can help or hurt private investment. The best kind of government spending is one that aids both asset creation and income generation. Such spending, even if financed by higher than targeted deficit, encourages (crowds in) private investment. However, a deficit, especially that does not lead to asset creation, can also hamper (crowd out) private investment and therefore stoke inflation. Only government expenditures designed to boost productive investments to offset the slowdown will pump prime the economy and exonerate finance ministers around the globe for rising fiscal deficits.
It's not that there are no large dollops of public expenditure taking place. The Rs 1,275,000-crore National Rural Employment Guarantee Scheme (NREGS), the Rs 25,000 crore on the farm loan waiver scheme and the Rs 25,000-crore largesse announced by the Sixth Pay Commission (SPC) for central government employees will all put significant sums of money into rural and urban consumer wallets. But all these spending programmes were well underway before the global financial crisis hit hard. The spending, ranging from the farm loan waiver to the SPC, and its growth effects were factored in by the government in February, when it presented the Budget... just that the government had not included any of it in its accounting at that time and they were all referred to as 'below the line', says Rohini Malkani, Economist, Citigroup India.
Much of the pump priming impact of these programmes has already been absorbed by the economy. And given the rising deficit, the government has little additional money to fund a New Deal -kind of project. Of course, government can simply borrow more to fund new programmes, but given the shortage of funds in the financial system, a stepped-up government borrowing will dry up funds (or raise the cost) for private sector a situation government is trying to avert. It's not that government spending hasn't helped create demand. The question is whether the demand creation is adequate and more importantly, if the demand and asset creation is proportional to the money spent on these programmes. The sporadic effects of government-led demand creation are evident.

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Source:Sify,Rediff