What fiscal stimulus was all about : 19th March 2010 Economic Times

Fiscal stimulus in the Keynesian framework consists of extreme affirmative government action through the Budget to boost economic activity. Traditionally, this concept would refer to increasing fiscal deficits wherein the government spends, through high borrowings or printing of currency, to provide purchasing power to the people so that demand is sustained.
Therefore, the pre-requisite of a fiscal stimulus is a high fiscal deficit. Such deficits are brought about by either higher expenditure or lower tax rates. The objective here is to analyse the routes chosen by the government and the extent of their success.
Table 1 shows that the stimulus was exhibited sharply in 2008-09 through the big increase in fiscal deficit by 166%. Subsequently, the increase in 2009-10 was moderate at 23% and has been largely withdrawn in 2010-11 . The interesting observation is that the stimulus does not appear to be really driven that much by expenditure, as total expenditure , as indicated by the size of the Budget had actually increased sharply before the financial crisis in 2007-08 , when the deficit was at 2.7% of GDP. The maintenance of this increase in 2008-09 was actually more due to higher inflation as inflation-adjusted total expenditure increased at a slower rate in 2008-09
Even in case we look at nominal expenditure , the increase in 2008-09 was on revenue account — the typical Keynesian variety of NREGA, where income was provided for the poor to spend money and got reflected in Plan expenditure. But the government did not spend on projects as seen in the decline in capital expenditure in 2008-09 , which was subsequently brought back to the 2007-08 level in 2009-10 .
The view evidently was the short run where the thrust was on reviving consumption by addressing issues of poverty. Further, the government spent more on the three critical components of non-development expenditure, i.e., subsidies, interest and defence, in 2008-09 . Subsidies were just about maintained in 2009-10 at 2008-09 level. The conclusion is that while there was nominal increase in expenditure in 2008-09 and 2009-10 , the stimulus was sharper in 2008-09 . A gradual withdrawal was evident in 2009-10 that has been hastened in 2010-11 .
How effective were these expenditures ? It must be realised that the country’s GDP growth had slid to 6.7% in 2008-09 from two successive years of over 9%. This was so as both, growth in private consumption expenditure and capital formation, had slowed down to 6.8% and 4.0% respectively in 2008-09 from 9.6% and 16.9% in 2007-08 . Further , in 2009-10 , growth in consumption and capital formation was tardy at 4.1% and 5.2%.
Therefore , the higher spending invoked by the government, which gets reflected in the social services and government administration component of GDP, displayed a high growth rate of 13.9% in 2008-09 and 8.2% in 2009-10 . This was a classic Keynesian stimulus of higher government expenditure compensating for the loss of demand generated by the private sector.The question now is really whether lower government expenditure will be substituted by the private sector to kickstart the economy in 2010-11 . Government expenditure of the non-projects variety cannot lead to sustained growth and can, at best, compensate for any shortfall in private sector activity. This is a major conclusion here.
How has the private sector been affected by the Budget? The government simultaneously has taken a major hit in its tax collection in 2008-09 and 2009-10 by reduction in excise and Customs duty rates that it seeks to reverse in 2010-11 through its duty rate reversals. Table 2 provides information on growth rates on the revenue side as well as effective rates. The effective duty rates have been calculated as follows: Customs collections to total imports and excise collections to GDP from manufacturing.
Table 2 reveals that indirect tax collections actually declined in the two crisis years and the effective tax rates have come down quite drastically by 3.7% in the case of Customs and 5.6% for excise duties. This was the stimulus provided on the production side to industry in particular that will be reversed in the coming year.
What are the takeaways from this analysis? The first is that the expenditure stimulus was more in 2008-09 than in 2009-10 . The second is that it was directed not at creating capital but more at providing relief at the lower level of income. The third was that it helped to compensate tardy growth in private consumption and capital formation.

Fourth, following from this thought, it may be explained that even though the fiscal deficit was high, the borrowing programme was non-obtrusive as it did not put pressure on the system as growth in credit was also tardy and there was enough room for this borrowing. Fifth, the lowering of tax rates provided an impetus for sure, as the government took a hit on tax collections. Therefore, it was Keynes at both the ends.
However, the point for debate is whether the present reversal of liberalism in this area will be compensated by the private sector growth. This will surely be the subject of debate in the coming year.