Assessment of the Policy Responses

The Indian fiscal policy response to the crisis can at best be summarized as having been preempted by political considerations that resulted in a fiscal expansion ahead of the global crisis and left only limited space to respond in the aftermath of the crisis. Hence the fiscal response after December 2008 could be argued to not have been as large as required.¹⁹ Given a high fiscal deficit (central and state combined) of 5.4% in FY2007–2008, India had limited fiscal maneuverability to begin with. However, due to electoral considerations a fiscal stimulus of nearly 4% of GDP was induced in the FY2008–2009 budget. This raised the combined fiscal deficit to about 10%, leaving barely any more for further fiscal stimulus after the crisis.

The fiscal stimulus, though very small in size as compared to other countries, worsened the fiscal deficit further, increasing it to 11.4% in FY2008–2009. The increase in fiscal deficit had two implications. First, it drew a strong response from international credit rating agencies and the sovereign credit rating of India was in the danger of being lowered. Any further reduction in India's credit rating could have serious implications for capital inflows. Secondly, the high fiscal deficit naturally led to an increase in government borrowings. Higher government borrowing also put a lot of pressure on the interest rate, as reflected in the 10-year bond yield rate going up along with the announcement of the new stimulus packages. The long run interest rate increase could have serious implications for private investment. The debt to GDP ratio was around 75% in FY2008–2009 (Figure 18 [ PDF 40.4KB | 1 page ]). The rise in public debt to GDP ratio can be worrisome as it is now well above levels reached in 1991 when the country faced a major crisis. However, the present situation is not as serious primarily due to the strong external sector balance that India has been successful in building up since the beginning of this decade.

Figure 19: Trends in Short Term and Long Term Interest Rates [ PDF 40.4KB | 1 page ]

In sharp contrast to the fiscal policy response, the monetary authorities in India acted aggressively once it was clear that inflationary pressures had subsided and growth was beginning to slacken. Unfortunately, because of the government's large borrowing requirement and the stickiness in deposit rates that keep the cost of funds high for the banks, the policy rate cuts have not filtered into the retail credit market. The commercial bank's lending rates, in real terms despite some reduction, are still very high and banks are not able to push up credit off-take. This is reflected in the continued decline in the growth of non-food credit off-take from commercial banks in recent months. The positive impact of monetary policy actions has therefore been somewhat limited.

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