Fiscal Stimulus – A Simple Guide!

Our honourable Prime Minister announced a “20 lakh Crore fiscal package” with a lot of fanfare. It gave a lot of hope and optimism to citizens, myself included. I got some queries on what does a fiscal stimulus package mean?

This is not an economics 101 class or attempt to decode the merits of the package announced. It is just a broad understanding of what a fiscal stimulus is and why is it announced.

The coronavirus has resulted in lockdown almost everywhere in the world. The extent and the time of lockdown vary depending on the demographics and the virulence of the virus and the rulers. Factories are shut, offices are closed, and there is no movement in travel internationally as many countries have locked down borders. Domestic travel is either restricted or is limited.

Revenues have come to a grinding halt except for essentials & Pharma.

The financial impact is felt by almost everyone. Companies, individual business owners, professionals. Some more than others. People in travel and hospitality will have a complete washout quarter. Costs are static, revenue is next to zero, and layoffs are rampant. The GDP of the economy will fall.

What is GDP?

The GDP is the gross domestic product which means the value of all the goods and services produced by a country.

When you expect an overall decrease in income the GDP of a the country goes down.

If you equate the country to a household than it is the value of all the income earned by every member of the family in a year. Suppose, the husband is a business owner, the wife an advertising professional, and the kid a doctor. All incomes put together is that family’s collective income and for a country income of every entity is the GDP.

Till such time that a cure or a vaccine is found, and a the closed sign continues, the loss of revenue cannot be estimated by the expert economists and statisticians.

In the example given above, suppose thanks to the lockdown, the husband’s business has no revenue, the wife has to take a cut in pay, and the son has retained his income. As the overall income is lower, the family will cut down expenditure. Will survive on the basics.

When the economy opens up this will have an unbelievable chain effect. The mobile & the car which was their planned purchase may get cancelled. As an effect, the car dealer may postpone or cancel a holiday. The travel company may lays off half the employees. 

The laid-off employees naturally with no income cannot spend and will become frugal. They may not pay rent to their landlords who again will have to forgo his spending.

The domino effect of all this is that the demand in the economy will fall drastically. The growth rate of GDP will fall.

We can safely conclude that this year we will produce fewer goods and services than last year. That seems a simple enough conclusion. No arguments there.

A contraction in GDP or a slowdown is a huge headache for an economy. It is like a kid flunking his 10th-grade exam, having a drug problem, and also getting diagnosed with diabetes all at once. Quite a challenge for the parents/teachers to tackle.

An economy is like a complex machine. There is very little scope for downtime. If there is a breakdown, parts are changed and back to work. A complete shutdown with many broken parts is a disaster. Who knows when will it get back on track?

Economists dread a slowdown or worse a recession as there are no easy quick fix pills. To pull out a country from a slump is an art and science and may need some divine intervention.

 A fiscal stimulus is just a booster shot to manage a slowing economy and stop it from falling into an abyss. It is an effort by the powers maybe to kick start a sluggish economy through some measures. The government spends from its coffers or cuts taxes to help the economy.

When demand in the economy is low, there is all around gloom & doom. Government spending on infrastructure or supporting weak businesses delivers a steroid shot to revive some confidence. A stimulus is a big brother coming in with an umbrella on a rainy day.

To cushion the blow of the effect of coronavirus governments all over the world are announcing measures to support their economy.

So,

This is a fiscal stimulus.

What is the 20 lakh Crore package announced by India?

Not going into deep dive in the package, in my opinion, the actual spending is close to 2 lakh crore. Mainly as food grains and pulses and cash support to the poor. Unemployment hits them the hardest, this is the least we can do for the poor. It wouldn’t be fair to starve some citizens to save other citizens’ lives.

The rest are in loans, tax rebates, government guarantees, and many other measures that are good but more of rhetoric.

You can read about the package here

& here

& here

India’s GDP last year was about 202 lakh crores. Experts estimate that fiscal packages’ actual spend would be about 1.5%or 2% of it.

While the developed economies are spending from 5-13% of their GDP. They can afford to do so.

Why Not?

Our fiscal deficit – ie the governments spend as against the income is already ~ 6% (Centre & state). The government borrows to bridge the gap.

As a country, we just cannot afford to spend too much to revive the economy. We borrow too much and we can go broke. Our coffers are not that strong.

Read about it here

The truth is India is the migrant of the world. No one is coming to save us. We will have to save ourselves.