Beating Recession – Government’s Role

It started as a US investment bank problem has slowly spread to the entire financial sector across the world. And now it is engulfing entire economies. There is a consensus that the world is rushing headlong into a prolonged recession. Columnists remind us of Great Depression, when US real economic output fell by a third between 1929 and 1933, unemployment rose from 3 to 25% and stock markets took 25 years to regain their peak.

There is a danger of governments tightening public spending or raising tariff barriers, thereby risking a deep recession. The 27 European countries that have free movement of capital, labor and products, are ringing with dissonance, and there may be some breakaways from the 15 that share a common currency. But the concerted response of leading countries suggests that they will not indulge in ruinous policies. Nevertheless, a global recession seems inevitable. The new President Elect is talking of rebuilding roads and bridges and giving tax rebates of $3,000 for every job created. China, which is expecting annual growth to slow down has proposed a fiscal stimulus package, including export rebates on 3,000 items.

China is much more dependent on exports than India. But India is globally entangled much more now than it ever was. We have liberalized financial flows in and out of the country, reduced tariff barriers and a quarter of our economy is dependent on trade. Our exports at 13.5% of gross domestic products are 50% higher than in 1991. India is no longer a closed economy and cannot insulate itself from a global recession.

The policy responses suggest that Indian government is leading the economy by looking at the rear-view mirror. Economic figures of the recent past are certainly better than those of countries already suffering. But the government seems to believe that Indian financial sector is de-linked from real economy and that Indian economy is de-coupled from the rest of the world. It doesn’t seem to notice what businesses in India already see-signs of a creeping slowdown. Because of recent inflation, tight money, high interest rates and now the wealth effect of lower stock prices and property values, demand is falling. Monetary initiatives have been tardy and timid so far. More aggressive monetary policies are inevitable, but by themselves will not avoid a painful slowdown.

What we need now is a coordinate fiscal stimulus. But investment-led expenditure takes a long time to plan properly, implement effectively and operate efficiently. At a time of a looming global recession there is a need for something that will immediately help rejuvenate the economy, create employment for our idle resources and protect us from global economic illness. India’s one billion consumers constituting in numbers the second largest market in the world can be a direct support for Indian Markets particularly FMCG. A consumption led stimulus through a measure simple to implement and quick in result is the need of the hour.

The government must immediately bring down incidence of excise duties-for all products except for the biggest contributors such as oil and tobacco-by about 20%. For instance, the 24% slab going down to 20% and so on. This move can be done by a simple executive action and implemented quickly. It is non-partisan, will have the support of the left and bring electoral benefits for the incumbents. Such a move would benefit the one billion consumers, over 90% of whom have not just unsatisfied wants but also unfulfilled needs. Sufficient idle production capacity and competition exist in the economy to ensure that the excise reductions will in large measures be passed on to the consumers. Proven price-elasticity of demand will encourage consumption and re-energize demand.

The move will reduce the pipeline inventories, get factories to hum again and lead to rehiring and employment creation. As the experience of the automobile industry shows, volumes will increase as happened after the excise reductions in the 2008 budget. It will improve corporate financial performance and therefore income tax collection while reducing the incidence of the regressive excise tax which, when coupled with the states’ sales taxes and other local taxes, imposes an unaffordable burden on the poorest consumers. It will also improve the capital markets and facilitate fund raising from the market for investment proposals.

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