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DAILY NEWS ANALYSIS

  • 06 August, 2019

  • Min Read

Fiscal wheels must also roll in order to make monetary policy effective.

GS-III: Fiscal wheels must also roll in order to make monetary policy effective

Context

Through four successive reductions in this year, RBI has reduced the repo rate by 110 basis points to 5.4%.

Status of the rate cut

  • The economy has been slow to respond to these incremental monetary stimuli.
  • Quarterly growth data show a continuing slowdown, mainly driven by sluggish demand, due to both external and domestic factors.
  • There is substantial excess capacity in the manufacturing sector.
  • With unutilized capacity, temporary and casual employees are being laid off and wage hikes are being postponed, reducing levels of aggregate disposable income, which is further reducing demand, particularly for consumer durables.
  • Unless capacity utilization improves, investment demand from the private sector is not likely to improve.
  • Repo rate reductions only provide enabling conditions to reduce the cost of borrowing. To be effective, adequate transmission needs to take place.

Limitations of Monetary Policy

  • Demand for investment and consumer durables has to increase, which is a function of income, much more than the cost of borrowing. For this, momentum has to be generated at the fiscal side.
  • Due to revenue constraints and legislative limits on borrowing, suitable countercyclical fiscal measures have not yet been taken.
  • Without a demand push from the public sector, monetary policy alone would not be effective.

What the government should do:

  • The countercyclical policy is primarily the responsibility of the central government.
  • A one-year departure from the budgeted fiscal deficit of 3.3% of GDP for 2019-20 can be justified at the current juncture.
  • It should be ensured that the entire additional borrowing above the budgeted level is spent on capital expenditure.
  • It is established fact that increases in government capital expenditures have much larger multiplier effects, as compared to increases in government revenue expenditures.
  • State governments and the central and state public enterprises should come on board and undertake additional investment spending on infrastructure.
  • This will push investment from the private sector, uplifting the infrastructure and construction sectors, and later spreading out to other sectors.

Together, the joint impact of the fiscal and monetary stimuli is expected to uplift the country’s growth from its present low level to levels comfortably above 7% and, eventually, closer to 8.5-9%. Sustaining growth at these levels is required if India were to become a $5-trillion economy by the end of FY25.

Source: Live Mint


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