By Mihir Sharma
When Prime Minister Narendra Modi recently announced a stimulus package for India, he said it was worth Rs. 20 trillion — $265 billion, equivalent to about 10% of the country’s GDP. This seemed to fit in with the amounts being spent by some rich OECD economies to deal with the fallout from the Covid-19 pandemic. Equity markets exulted.
In Modi’s India, though, it’s usually wise to wait for the details. Now that they’re out, the markets — and many economists — are disappointed. Actual spending is a fraction of what Modi promised, they argue — perhaps as little as 1% of GDP. Once equity traders added up the package’s components, the markets duly sank back into gloom.
In fact, Modi and his advisers have gotten it right, and governments around the world could learn from their caution. While India’s fast-growing economy faces an unprecedented slowdown thanks to the pandemic — shrinking as much as 45% annualized in the second quarter of 2020, according to Goldman Sachs — spending on everything in sight isn’t the best solution.
India’s policymakers found the correct prescription because they began with the proper diagnosis. A bigger stimulus would have been the right way to address a crisis in aggregate demand. But that’s not India’s problem: Until we figure out the best way to reopen, the country needs less economic activity not more. The real issue is the lockdown imposed to slow the spread of the new coronavirus.
Instead of wasting money it doesn’t have, the government has tried to address the problem we do have. Government spending works if no other event, policy or signal can address the coordination problems that underlie a collapse in aggregate demand. In this case, we know there is such a signal: an end to the current emergency. In the interim, what the government needs to do is figure out how to preserve those things that would allow the economy to respond to that signal — lives, businesses and contracts.
Yes, that can cost money and governments are the spenders of last resort. But even more important than the government’s ability to pay is its ability to absorb risk and provide liquidity. India’s rescue package is structured around precisely these strengths. It includes the promise, for example, of roughly $40 billion in collateral-free loans to small businesses that would be completely guaranteed by the government.
We can quibble over the details — it’s a mistake to limit such loans to existing borrowers, for instance, when lots of smaller businesses may want to borrow for the first time — but you can see the government’s rationale. People who believe their business will recover can take on a loan for payments that they have to make; banks will be happy to cover them, since they’re being underwritten by the government. Instead of the government figuring out who to pay to reopen the economy, banks and businesses will make the decision. While we’ll have to see how it works in practice – any delays in the rollout and the whole thing will fall apart — the idea is sound.
Thanks to this focus on liquidity support and risk underwriting instead of across-the-board spending, India’s debt might remain under control instead of exploding. Most importantly, Modi’s government has not been foolish enough to reverse decades of painful institutional reform and demand the central bank start monetizing its debt. That would have spelled the death knell for India as a mature economy — and sent borrowing rates for everyone through the roof.
If some economists are furious, that’s because economists, like generals, are always battling the last crisis. India’s government learned from it instead, according to Finance Minister Nirmala Sitharaman: After the 2008 financial crisis, the government “just opened the floodgates and kept it open for a long time. At the end of the day, you had [the 2013] taper tantrum, double-digit inflation and food inflation hitting the roof.”
Caution is wise. Unlike many of their global peers, India’s policymakers seem to recognize that, faced with an unprecedented emergency, their primary responsibility is to keep things stable until it is clear how best to intervene. It’s not to dissolve one institutional constraint after another on the pretext of fighting this crisis.
Modi’s economic record has been far from exceptional, so how has his government proven so astute at this moment? Perhaps it’s because the prime minister himself is something of a fiscal hawk. Or perhaps fears that India might be downgraded concentrated minds in New Delhi. Had ratings agencies downgraded India, there would have been no chance of borrowing enough to provide stimulus when it might actually be needed — whether six, 12 or 18 months from now.
And, yes, more spending will probably be required. If this emergency lasts long enough, India’s poor will need direct cash transfers, for example. Let’s hope that income support, when it comes, is as cautiously designed. For now, look to Modi’s India as a global example, not a disappointment.
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