Fiscal Stimulus

Fiscal Stimulus: Navigating Economic Challenges

Context: During periods of economic downturn or crisis, fiscal stimulus becomes a crucial tool for governments to boost economic activity. This approach, rooted in Keynesian economics, involves increased government spending and tax relief measures to stimulate demand and counter the negative impacts of a recession.

2008 Global Recession:

1. Challenges Faced:
• In 2008, India faced the repercussions of a global recession. Tax revenues dwindled, demand slumped, and the corporate sector deferred investments, posing a threat to employment.
2. Keynesian Solution:
• The government, adopting a Keynesian approach, implemented a fiscal stimulus package to counter the economic slowdown. This involved deviating from Fiscal Responsibility and Budget Management (FRBM) limits to allow for higher borrowing and spending.
3. Fiscal Measures:
• Higher Deficit and Spending: The government increased fiscal deficit to facilitate higher spending, injecting funds into the economy.
• Tax Reliefs: Both direct and indirect tax reliefs were introduced to incentivize spending and support businesses.
4. Monetary Measures:
• Simultaneously, monetary stimulus measures were implemented:
• Rate Cuts: Reduction in interest rates to encourage borrowing and spending.
• SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio) Cuts: Lowering these ratios to infuse liquidity into the banking system.
5. Impact and Recovery:
• The combined fiscal and monetary stimulus was effective in preventing a prolonged economic slowdown. The growth rate rebounded to 8.4% in the fiscal years 2009-10 and 2010-11.

Challenges of Sustaining High Fiscal Deficit:

1. Unsustainable Levels:
• While the fiscal stimulus provided a timely boost, maintaining a high fiscal deficit in the long term was deemed unsustainable.
2. Rollback to Normal Levels:
• Beginning in 2010-11, a calibrated approach was adopted to roll back fiscal deficit levels to adhere to normal benchmarks.

2020 Global Pandemic:

1. Lockdown Impact:
• In 2020, the global pandemic necessitated another departure from FRBM limits. The lockdowns severely impacted economic activity, prompting the government to resort to fiscal measures to support businesses and individuals.

Conclusion: Fiscal stimulus, though effective in managing economic crises, requires a balance. While it provides short-term relief, sustained high fiscal deficit poses challenges. Governments must carefully calibrate their fiscal policies, ensuring a return to normalcy once the immediate crisis is mitigated. The 2008 and 2020 instances illustrate the pragmatic use of fiscal stimulus to navigate economic challenges.