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ECONOMIC REVIVAL PACKAGES - Panacea or Pandora’s box

It’s 2010.The recession is probably “bottoming out”. The fervor with which “pink slips”
were handed out has calmed down, stock markets across the world have stabilized, hiring is
back in favour as are bonuses, banks are a little less paranoid while lending, corporates are
taking tentative steps forward………………… all in all normalcy is creeping back into
life.

This “turn around” can be attributed to the collective efforts of dispensations & central
banks world over who have been diligently administering generous doses of what is called
“fiscal stimulus”, either in the form of tax cuts, change in key rates , direct infusion of
money into the market ,introduction of new spending measures by the government in the
form of new projects etc.

While India’s stimulus package is valued at 12% of the GDP, Germany’s is approximately €
50 bn, Singapore’s is $20.5 bn & North Korea’s is estimated at $40 bn. According to an
estimate by the IMF the value of total fiscal stimulus given by economies worldwide
amounted to US $ 2.18 tn or 3.5% of the world GDP as on March 09.

Thus, it is apparent that there is an implicit consensus among nations that it is the duty &
responsibility of the government to jump to the economy’s rescue when the going is not
good. It may also be interpreted as an endorsement of the fact that “stimulus packages”
work.

But are they benign?

Due to monetary easing more money flows into households & corporates which spurs
demand for everything that money can buy. But the supply remains more or less
unchanged. With too much money chasing too few “purchaseables”, inflation becomes an
inevitable consequence. In fact, the high inflation nightmare that we the Indians are going
through these days is partly the effect of the stimulus measures .

While inflation is a relatively immediate consequence of economic revival packages, a far


more graver impact is registered by the way of slower economic growth in the long run.
According to a recent article published in the Economic Times ,the findings of a research
undertaken by Carmen Reinhart of Maryland University & Kenneth Rogoff of Harvard
University suggest that high government debt extracts a toll in terms of both lower growth
& higher inflation. Since revival packages are always government sponsored , they add to
the government’s debt burden whose ill-impacts have been documented by Reinhart &
Rogoff. An important spin-off of a deteriorating debt /GDP ratio is downgrading of a
nation’s rating by rating agencies like Standard & Poor, Fitch etc that reduces the
attractiveness of an economy to foreign investors.

Moreover the certainty that the government will step in every time the economy is in
doldrums, instills a sort of recklessness & irresponsibility in the buying , saving & risk
taking habits of individuals & corporates .Thus government dole-outs also pose a “moral
hazard”.
Undoubtedly, economic revival packages do entail undesirable repercussions. But in their
absence the situation may turn even more dire. Once recession makes itself manifest ,
“mistrust” becomes rampant . Banks hesitate to lend, specially for commercial purposes
.Moreover due to increased risk perception of investors, cost of funds tends to go up. Under
such circumstances it becomes difficult to continue business. Closing down of a unit
translates into lay-offs & pink slips, which in turn reduces the purchasing power of
consumers, thereby making “bottomlines” the ultimate casualty. Thus, a vicious cycle is set-
off. In absence of artificial stimulus this cycle grows in terms of spread & magnitude ,
rendering the problem uncontrollable & endangering the economic future of the nation
thereby throwing open the real “ Pandora’s box”.

Steps like changes in key rates like CRR, SLR , lowering of interest rates prompt
businessmen to borrow & expand or at least continue at the existing pace, spending
measures by government compensate for loss of spending by private parties, launch of
government projects creates employment when the general trend is against hiring, tax
breaks increase the disposable income of consumers thereby making them spend more.
Thus it may be concluded that stimulants can effectively arrest the slump ,which is why
they are so popular & have even found the favour of economists. Not surprisingly the
debate often centers around the “how much” & “when” of fiscal stimulus & not the
“whether” of it.

The anticipated aftereffects of fiscal stimulus plans highlighted in the earlier part of this
article are as real as their promised benefits. Furthermore it may also be conceded that the
troubles that may surface in the long run are more compelling than the short to mid-term
gains that are supposed to flow from the stimulants. But one can think of tomorrow only
when today is secure.

OUR PARTING SHOT-stimulus packages may be opposed, written against ,questioned ,


wished away or at best curbed but can never be done away with.

SUBMITTED BY-Manisha Pattnaik

Shrabani Nayak

Ayesha Pattnaik

MFC,Part 1