Demonetisation has severely compressed aggregate demand and unleashed a recessionary tendency in the “white” economy.
It will worsen the recessionary crisis unleashed above all by the demonetization measure; and it also portends an economic strategy that, in the face of the protectionism being introduced by Donald Trump, will further import unemployment into the economy.
It is amply clear by now that while demonetization has been a complete failure in denting the black economy, it has severely compressed aggregate demand and unleashed a recessionary tendency in the “white” economy. The reason for this is simple: it has led to a transfer of purchasing power in the form of cash from the pockets of the people where it would have been used to buy goods and services, into the vaults of banks where it is just lying idle. The primary impact of this recession is on the so-called “informal sector” where more than 80 percent of the work-force is employed, producing almost half of the GDP.
But the multiplier effects of the decline in output in the “informal”, or the petty production, sector are also felt on the “formal” sector that is dominated by big capital. The recession therefore gets generalized to the economy as a whole. This Modi-induced recession, it must also be noted, is occurring in a situation where there are other factors too which are contributing to a contraction in demand, namely the belated impact of the world capitalist crisis which has now spread to India and China, and the protectionism introduced by the Trump administration (on which more later).
With the economy thus sinking into a recession the obvious course which the budget should have taken is to expand demand through larger government expenditure financed by taxing the rich or even enlarging the fiscal deficit. Instead what the budget has done is to further contract demand. The total government expenditure which had increased by around 12 percent between 2015-16 and 2016-17 (RE) is supposed to grow only by about 6 percent between 2016-17 (RE) and 2017-18 (BE). As a proportion of the GDP, government expenditure is supposed to decrease from 13.7 percent in 2016-17 to 12.7 percent in 2017-18.
It is of course true that since the budget has been presented at the beginning rather than at the end of February, the third quarter data for 2016-17 were not available when it was prepared, so that the exact figures in the budget mean very little. But the fact that the budget is completely unconcerned about the recessionary tendency already underway in the economy, and, far from seeking to counter it, is actually more pre-occupied with “fiscal rectitude” which itself necessarily aggravates recession (since it entails that a reduction in GDP which lowers tax-revenue must also lower government expenditure), cannot be denied.
An expansion of the fiscal deficit in the current juncture would have had unambiguously beneficial effects on the economy without the usual possible pitfalls associated with it. Purchasing power has been impounded from the people and is lying idle with the banks. It should not of course have been impounded in the first place; but since it has been impounded, if the government, at the very least, had used this purchasing power for its own spending, then it could have killed two birds with one stone. First, the demand contraction caused by the withdrawal of purchasing power from the economy could have been offset, and even more than offset (if government spending had been in areas which are more employment-intensive than the areas where the withdrawn purchasing power would have been otherwise spent). And secondly, it would have saved the exchequer resources that would otherwise be transferred to banks. This second point needs clarification.
Banks will have to pay an interest on the deposits that have been forcibly extracted from the public and are lying idle with them. There is however little additional demand for credit from borrowers whom they consider “creditworthy”: such borrowers were not credit-constrained to start with, so that they have little incentive to borrow more in the first place; in addition, with recession threatening them, their incentive to borrow is further dented.
Banks therefore are threatened with losses because of the Modi government’s saddling them with huge additional deposits: they have to pay interest on these deposits but they earn nothing from such deposits. The government under these circumstances is planning to put some interest income in the hands of banks out of budgetary resources. There are two ways in which it plans to do so.
One is through the Reserve Bank selling them government securities which are already in its possession, so that they get an interest income which the RBI foregoes. But since the RBI’s profits come to the government budget (as it is fully owned by the government), this means a transfer from the government budget to banks. But lest the RBI runs short of securities, the government is taking recourse to another measure as well. This is to issue securities to banks on which it pays an interest but whose proceeds it does not spend. This too represents therefore a transfer from the government budget to banks.
But compared to either of these channels of pure transfer, if the government issued fresh securities whose proceeds it actually spent, i.e. if it actually ran a fiscal deficit of the same magnitude, then, while the interest paid by it would be no different from in either of the cases mentioned above, the spending of the proceeds would benefit the economy. Not doing so in other words, i.e. avoiding a fiscal deficit would mean handing over an interest income to banks out of budgetary resources, without any benefit accruing to the economy. It would be the silliest policy to pursue; but that is exactly what the budget has done.
True, with new notes being printed to replace the demonetized ones, the amount of deposits with the banks would come down, so that these resources would no longer be available with banks for the government to borrow. But the government has already said that it would not fully replace the value of demonetized notes, that it would leave a gap of Rs.1.5 to 2 lakh crores, in order to force people towards cashless transactions. At least this amount, of Rs.1.5 to 2 lakh crores, should be available with banks “for keeps”, and the government could have borrowed it; but it has chosen not to.
Even the pitfalls generally associated with fiscal deficits would have been absent in the present context. The first pitfall associated with a fiscal deficit is the possibility of excess aggregate demand, and hence of a demand-pull inflation caused by it. But since the current situation is one of recession generated by insufficient demand, the question of inflation simply does not arise at present.
The second pitfall is that government borrowing means a corresponding increase in private claims upon the government, and hence in private wealth, which typically entails an increase in wealth inequality in society. But in the present case, since the deposits have been mobilized from people across the spectrum, from the poor as well as the rich alike, the fiscal deficit would not mean an increase in the wealth mainly of the rich (who usually save a larger proportion of their incomes and with whom therefore government securities are mainly held, directly or indirectly); it would rather entail an increase in claims upon the government by all, so that there would not be so much of an increase in wealth inequality.
Sheer commonsense therefore would have dictated an increase in the fiscal deficit in the current juncture, but the budget has kept the ratio of fiscal deficit to GDP at the same level as in 2016-17. And it has done so, while keeping MGNREGS expenditure at virtually the same level as in 2016-17 (Rs. 48000 crores in 2017-18 BE against Rs.47499 crores in 2016-17 RE), and while keeping social sector expenditures down (e.g. by pegging education and health expenditures as proportions of GDP at the same levels as in 2016-17).
The reason it has adopted this silly course of pursuing “fiscal rectitude” in the midst of a recession is because it does not wish to offend global finance which abhors fiscal deficits. But appeasing global finance, which is anyway against the interests of the people, becomes particularly absurd against the backdrop of Trump’s protectionism.
Trump’s protectionism in a context where no increase in aggregate demand is taking place in the world economy (and Trump himself is not visualizing any larger government spending in the U.S. but only large tax concessions to capitalists which does not per se increase aggregate demand) amounts to a “beggar-my-neighbour” policy, i.e. to snatching a larger amount of activity and employment from other countries including India. To protect employment in India against this policy of Trump, the Indian government should be imposing protectionism of its own, and, since any such move on India’s part might trigger a financial outflow, putting in place capital controls. In the shadow of such capital controls, the government can expand domestic aggregate demand without worrying about appeasing globalized finance capital.
This has to be the response of the Indian government since there is no other possible response to Trump’s “beggar-my-neighbour” policy that is not merely silly. This being so, a start could have been made in the 2017-18 budget by increasing the fiscal deficit and turning away from the policy of appeasing international finance which neo-liberalism has forced on the economy. The government by not doing so has clearly indicated that it does not understand the new situation arising in the world economy because of Trump’s protectionism.
The 2017-18 budget therefore not only has serious adverse consequences for the year 2017-18 itself, but also suggests that the government, trapped within a mindset that does not comprehend what is happening in the world economy, is bent upon importing the unemployment that Trump is trying to export to the rest of the world.
Courtesy: The Citizen