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Power of Government's Booster Shot

Does the Government's Booster Shot Have Enough Power?

The government has announced a package of measures that is intended to stimulate the economy. Among other things, the measures include reduction of the CENVAT duty by four per cent, breaks for exporting companies, low- and mid-priced housing, for infrastructure.

How far will the package go in tackling the global economic crisis' affect on India? To answer this question, let us look at what a fiscal package like this is intended to do. Basically, the idea of a fiscal stimulus is to increase economic activity. There are two ways of doing that-either the government spends money directly or it causes more money to be available to individuals and companies. Individuals would, presumably, spend the money and companies would use it to either invest in capacity or drop prices or do something else that would boost economic activity.

The package announced today has elements of increased direct expenditure by the government as well steps to stimulate the private sector. There isn't a great deal of information available yet about what the direct expenditure will consist of. All that the government has stated is that this year's plan expenditure will be increased by Rs 20,000 crore or about eight per cent. The stimulus to the private sector has many elements but the broadest one is the reduction of the Cenvat duty by four percent across the board.

Will it be Enough?
While the package has generally been welcomed, it's not easy to see the magnitude of the impact it will have. One way of measuring the magnitude would be to compare this package to the size of the economy. The total size of all elements of this package add up to around 0.6 percent of GDP. If this kind of a boost is targeted well over the remaining four months of this year, then it would probably have a reasonably strong effect. However, a good chunk of this is the Rs 20,000 crore of additional plan expenditure. The Government of India's track record in being able to direct such expenditure in an efficient, productive and time-bound manner is questionable, to say the least.

The next major chunk is the Rs 8,000 crore worth of CENVAT reduction. Depending on the level of competition for a product, this could lead either to lower prices and increased demand or to higher profits for manufacturers. As things stand, some companies like Maruti have already announced price cuts. Others are indicating that they'll wait at least to make sure that their input costs also come down.

Deficits are the Dampener
Will these measures succeed? One thing is clear that given the real slowdown that can be seen across the economy, the size of this stimulus is not adequate. Unfortunately, the high fiscal deficit prevents the government from creating a sizeable package. During the boom years of 2003-2008, the government failed to use the buoyant tax revenues to curb its rampant deficit. Instead, like a kid with his first credit card, it went on a spending spree. Now, when fiscal measures are needed, the government is already neck deep in deficits and has limited room for manoeuvre. The fiscal situation is likely to get much worse as the year progresses. Given the corporate situation, the government's tax revenues are bound to take a big hit in the months to come.

Loss of Confidence
There's another factor that probably overrides all of this, and that is the loss of confidence both at an individual and corporate level. People are not spending and companies are not investing because they are uncertain about the future. If an individual is not sure how much he will be earning a year down the line, then a ten thousand rupee drop in a car's price is not going to make him a buyer. The same thought process also governs corporate expansion plans. Even if the liquidity and rate issues are solved, the loss of confidence can only be repaired by a reasonably long period during which the real situation improves. This hasn't even started yet.

Here's the complete list of actions, as announced by the government under the fiscal stimulus plan of December 7th, 2008:

1. Plan Expenditure:
In order to provide a contra-cyclical stimulus via plan expenditure, the Government has decided to seek authorisation for additional plan expenditure of upto Rs 20,000 crore in the current year. In addition, steps are being taken to ensure full utilisation of funds already provided, so that the pace of expenditure is maintained. The total spending programme in the balance four months of the current fiscal year, taking plan and non-plan expenditure together is expected to be Rs.300,000 crore.
The economy will continue to need stimulus in 2009-2010 also and this can be achieved by ensuring a substantial increase in plan expenditure as part of the budget for next year.

2. Reduction in Cenvat:
As an immediate measure to encourage additional spending, an across-the-board cut of 4% in the ad valorem Cenvat rate will be effected for the balance part of the current financial year on all products other than petroleum and those where the current rate is less than 4%.

3. Measures to Support Exports
i) Pre and post-shipment export credit for labour intensive exports, i.e., textiles (including handlooms, carpets and handicrafts), leather, gems & jewellery, marine products and SME sector is being made more attractive by providing an interest subvention of 2 percent upto 31/3/2009 subject to minimum rate of interest of 7 percent per annum
ii) Additional funds of Rs.1100 crore will be provided to ensure full refund of Terminal Excise duty/CST.
iii) An additional allocation for export incentive schemes of Rs.350 crore will be made.
iv) Government back-up guarantee will be made available to ECGC to the extent of Rs.350 crore to enable it to provide guarantees for exports to difficult markets/products.
v) Exporters will be allowed refund of service tax on foreign agent commissions of upto 10 percent of FOB value of exports. They will also be allowed refund of service tax on output services while availing of benefits under Duty Drawback Scheme.

4. Housing
Housing is a potentially very important source of employment and demand for critical sectors and there is a large unmet need for housing in the country, especially for middle and low income groups. The Reserve Bank has announced that it will shortly put in place a refinance facility of Rs.4000 crore for the National Housing Bank. In addition, one of the areas where plan expenditure can be increased relatively easily is the Indira Awas Yojana. As a further measure of support for this sector public sector banks will shortly announce a package for borrowers of home loans in two categories: (1) upto Rs.5 lakhs and (2) Rs 5 lakh-Rs 20 lakh. This sector will be kept under a close watch and additional measures would be taken as necessary to promote an accelerated growth trajectory.

5. MSME Sector
The Government attaches the highest priority to supporting the medium, small and micro enterprises (MSMEs) sector which is critical for employment generation. To facilitate the flow of credit to MSMEs, RBI has announced a refinance facility of Rs.7000 crore for SIDBI which will be available to support incremental lending, either directly to MSMEs or indirectly via banks, NBFCs and SFCs. In addition, the following steps are being taken.
(a) To boost collateral free lending, the current guarantee cover under Credit Guarantee Scheme for Micro and Small enterprises on loans will be extended from Rs.50 lakh to Rs.1 crore with guarantee cover of 50 percent.
(b) The lock in period for loans covered under the existing credit guarantee scheme will be reduced from 24 to 18 months, to encourage banks to cover more loans under the guarantee scheme.
(c) Government will issue an advisory to Central Public Sector Enterprises and request State Public Sector Enterprises to ensure prompt payment of bills of MSMEs. Easing of credit conditions generally should help PSUs to make such payments on schedule.

6. Textiles
(a) An additional allocation of Rs.1400 crore will be made to clear the entire backlog in TUF Scheme.
(b) All items of handicrafts will be included under 'Vishesh Krishi & Gram Udyog Yojana'.

7. Infrastructure Financing
A large number of infrastructure projects are now being cleared for implementation in the Public Private Partnership mode. These projects may experience difficulty in reaching financial closure given the current uncertainties in the financial world. In order to support financing of such projects, Government has decided to authorise the India Infrastructure Finance Company Limited (IIFCL) to raise Rs.10,000 crore through tax-free bonds by 31/3/2009. These funds will be used by IIFCL to refinance bank lending of longer maturity to eligible infrastructure projects, particularly in highways and port sectors. In this way it is expected that IIFCL resources used for refinance can leverage bank financing of double the amount. Depending on need, IIFCL will be permitted to raise further resources by issue of such bonds. In particular, these initiatives will support a PPP programme of Rs.100,000 crore in the highways sector.

8. Others
(a) Government departments will be allowed to take up replacement of government vehicles within the allowed budget, in relaxation of extant economy instructions.
(b) Import Duty on Naphtha for use in the power sector will be eliminated.
(c) Export duty on iron ore fines will be eliminated and on lumps will be reduced to 5%.