Policy Responses

4.1 Fiscal Stimulus

It should be pointed out that the initial fiscal stimulus was actually provided in the budget for FY2008–2009, announced in February 2008. Electoral considerations made this into an expansionary exercise that included massive increases in public outlays in support of employment guarantee schemes, farm loan waivers, pay commission rewards, and increases in food and fertilizer subsidies. This fiscal expansion is expressed by the revenue deficit increasing from 1.4% of the GDP in FY2007–2008 to 4.3% in FY2008–2009. At the same time the fiscal deficit of the central government increased from 2.7% in FY2007–2008 to 6.1% in FY2008–2009. The expansionary public outlays included some measures that implied a hefty transfer of purchasing power to farmers and to the rural sector in general. These included farm loan waivers, funds allocated to the National Rural Employment Guarantee Program (NREGP), Bharat Nirman (targeted for improving rural infrastructure) Prime Minister's Rural Road Program, and a large increase in subsidies for fertilizers and electricity supplied to the farmers (Table 6 [ PDF 49.5KB | 1 page ]). All of these measures were taken because of political considerations and not in response to the global crisis. Nevertheless, they have helped to shore up rural demand for both consumer durables and non-durables. In effect the higher than expected GDP growth rate in both the third and fourth quarters of FY2008–2009 could be attributed to the budgetary splurge announced in February 2008. While this has succeeded in shoring up GDP growth by raising rural demand, it did not leave much fiscal space for the Government of India to respond in any significant manner to counter the impacts of the global downturn.

However, some efforts were still mounted to counter the effects of the global economic slow down. Three fiscal stimulus packages—one each in the months of December, January, and March—were announced. These in aggregate amounted to Rs crore 106,050 or US$21 billion,¹⁴ which is approximately 2% of the GDP. This can be compared to the 4% of GDP that was provided as stimulus in the FY2008–2009 budget discussed in the paragraph above. The three post-December 2008 stimulus packages mainly are comprised by increased government spending on infrastructure, reduction in indirect taxes, and some assistance for export-oriented industries. In an attempt to boost the infrastructure spending that has been acknowledged as the most effective tool to counter economic downturn, the Government of India has increased its planned spending by US$4 billion and has also allowed the state governments to borrow an additional amount of US$6 billion from the market. Apart from this, the India Infrastructure Finance Company Limited (IIFCL), a special purpose vehicle (SPV) established in 2007, has been allowed to issue interest free bonds worth US$6 billion for refinancing the long-term loans for various infrastructure projects.

Secondly, to prop up domestic demand the central excise duty was gradually slashed from 14% in December 2008 to 8% in March 2009 on all products except petroleum products. Likewise the services tax rate has also been brought down from 12% to 10%. The government has also provided some relief to export-oriented industries through subsidizing interest costs of exporters by up to 2%, subject to a minimum rate of 7% per annum. It has also allocated US$240 million for a full refund of terminal excise duty or central sales tax, wherever applicable, and another US$80 million for various export incentives schemes. The direct fiscal burden of all the aforementioned measures adds up to about 2% of total GDP. This looks rather small in comparison to the size of the stimulus in some other economies like the PRC and the US. However, if we include the stimulus provided in the FY2008–2009 budget, the Indian government has in effect expanded its fiscal outlay by 6% of GDP during FY2008–2009. It can be argued that the economy may have fared better if more fiscal space was available to boost domestic demand to counter the collapse of external demand that started in November 2008.

4.2 Monetary Policy Response

With the objective of maintaining price stability alongside a reasonable rate of economic growth, the last two years have been very hectic for policymakers at the RBI. After a comfortable period of low inflation, the Indian economy started feeling the pressure of rising global commodity prices in the first quarter of FY2004–2005. In response to this rise in inflation, the RBI started tightening monetary policy in September 2004, raising the cash reserve ratios from 4.5% to 5.0%. As the inflationary situation worsened in the subsequent period, the tightening of monetary policy became even more aggressive. Consequently, inflation declined from around 8% in the middle of 2004 to less than 4% in September 2007. Nevertheless, coinciding with the rising global inflation trends, domestic inflation once again started increasing towards the end of 2007 and became a major headline in the first week of June 2008 when it entered the double-digit range for first time since the 1991 BOP crisis. It drew a sharp reaction from the RBI and the speed of monetary tightening was further increased. This credit tightening from FY2004–2005 onward ensured a soft landing of Indian economy, which began overheating over the past three years with the actual growth rate exceeding its potential growth rate. As a result the growth rate began to slow down from the middle of FY2007–2008.

In the wake of global financial crisis and its potential adverse effects on the Indian economy, monetary policy shifted gear and became expansionary from October 2008. The rapid decline in Wholesale Price Index (WPI) inflation, which has come down from its peak level of around 13% in August 2008 to less than 1% in April 2009, allowed the RBI to completely shift its focus from inflation to growth. Since October 2008, the RBI has injected a considerable amount of liquidity into the economy through a series of policy rate cuts. The cash reserve ratios of banks has been brought down from 9% to 5%, while the repo rate¹⁵ has been slashed by 425 basis points. Further, in order to discourage the banks from parking overnight funds with the RBI, the reverse repo rate¹⁶ has been gradually reduced from 6.0% in November 2008 to 3.25% in April 2009. The statutory liquidity ratio (SLR) has been lowered by one percentage point. Apart from this, some special refinancing schemes have also been announced to improve the liquidity for certain sectors (Table 7 [ PDF 48.1KB | 1 page ]). The cash reserve ratios reduction of 400 basis points since September 2008 alone has led to an injection of US$32.7 billion. In addition, another sum of US$12.9 billion has been injected through unwinding the market stabilization scheme. As of April 2009, a cumulative amount of nearly US$80 billion has been pumped in to the system (RBI 2009d).

As a result of the policy rate cuts, the prime lending rates of commercial banks have come down from 13.75–14.0% in October 2008 to 12.0–12.5% January 2009. The call money rates have also remained stable at low levels and the overnight money market rate has remained within the liquidity adjustment-facility corridor.

Apart from the above-mentioned initiatives, the RBI has also liberalized the ECBs and FII related norms. To attract the foreign portfolio investors, the FII limit on corporate bonds has been increased from US$6 billion to US$15 billion. At the same time, in an attempt to boost the construction sector, developers have been permitted to raise ECBs for integrated townships projects, while NBFCs dealing exclusively with infrastructure financing have also been allowed to access ECBs from multilateral or bilateral financial institutions.

It could be argued that the three fiscal stimulus packages, in conjunction with the transfer of purchasing power to the rural economy through increased budget outlays on the rural sector and the hike in minimum support prices of various crops, have saved aggregate demand and prevented GDP growth from plummeting in to negative territory. This has also been helped by the quick monetary policy response discussed above. In fact, in hindsight, our shock-augmented leading indicator model that some experts at ICRIER have been using to forecast GDP growth for India¹⁷ verifies this hypothesis. With the full impact of the external shock, we were expecting a growth rate of 5.3% in the fourth quarter of FY2008–2009. Nevertheless, with an actual growth rate of 5.8%, our calculation suggests that the fiscal stimulus has neutralized nearly 20% of the impact of the external shock. If we go with this line of argument, it seems that the growth will pickup marginally in the coming quarters because the monetary policy measures taken so far are expected to come in to play. Despite this, any hope for a major revival of economic growth in FY2009–2010 looks unrealistic as the positive impact of fiscal measures, such as the implementation of 6th Pay Commission, is bound to taper off. According to our revised forecast, in a best-case scenario GDP would grow by 6.0% in FY2009–2010 while in the worst-case scenario it would only manage a growth rate of 5.0%. Other agencies like the IMF, World Bank, and ADB have also estimated Indian GDP growth in FY2009–2010 at similar levels in their latest forecasts released in March 2009. Thus, the Indian economy will come down from the 9.0% level that it had achieved in the last four years to 6.0–6.5%. The growth targets for the XI Plan¹⁸ will also have to be lowered.

Figure 17: Actual and Forecasted Quarterly GDP Growth [ PDF 43KB | 1 page ]

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