Next round of fiscal stimulus: Question is when and how to do it

The Indian government has received much stick for the weak stimulus it has given so far, amounting to about 2 per cent of gdp. 

Following the onset of the pandemic, other economies vied with each in doling out large stimuli, covering support for both individuals and firms across the board. The government here chose to be far more cautious  and relied instead on monetary policy and the banking channel to ride out the lockdown.

Six months on, it does appear that the government called correctly. The economic outcomes from large fiscal stimulii elsewhere have been pretty modest. Even after sticking to borrowing limit of Rs 12 crore, which is the limit set for now, India's combined fiscal deficit for the centre and the states will be around 12 per cent of gdp. Any further stimulus will cause the fiscal deficit and  public debt to rise to a level where  a rating downgrade becomes inevitable, followed by an exodus of foreign capital.

More importantly, we have seen that large fiscal stimulii have not been effecting during the lockdown. Massive cash transfers and payroll support for businesses has not prevented a contraction in GDP. The stimulii have been wasted, so to speak, and the advanced economies have seen their debt to gdp ratios rise to well above 100 per cent.

Now that the lockdown is well under way, is it time for another dose of fiscal stimulus? Yes, except that inflation is now trending at above the inflation target limit of 6 per cent. We may opt for another round of fiscal stimulus once inflation falls below 6 per cent- and, I would argued, it should happen through direct monetisation of the deficit. Then, fiscal deficit does not rise. Inflation would have fallen below 6 per cent. More government spending can happen without inviting a rating downgrade.

More in my BS column, Now is not the time for stimulus