How to pay for the stimulus (The Hindu)

Mains Paper 3: Economy 
Prelims level: Debt financing and equity financing
Mains level:  Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment

Context:

• •    Former Prime Minister Dr. Manmohan Singh and his colleague Praveen Chakravarty have, in these pages, written on the appropriate policy response to the currently depressed state of the economy. 
• •    They present greater public spending as the sine qua non of such a revival, and they are absolutely correct in this diagnosis.  

Public spending:

• •    Greater public spending will increase the fiscal deficit and this expansion has to be financed. 
• •    Theoretically it can be financed by higher taxes. 
• •    However, when the economy is in a recession, this is usually not in the reckoning even though the balanced-budget multiplier is one, i.e., output expands by exactly the same amount as the increase in government spending. 

Debt Vs. Money financing:

• •    They are issuing debt to the public, and borrowing from the Reserve Bank of India (RBI), termed ‘money financing’ as it increases the money supply. 
• •    Example: Dr. Singh and Mr. Chakravarty plump for increased debt. While they do not rule out of court money financing, they suggest that it may be imprudent to do so. 
• •    Instead, they recommend borrowing from the World Bank and the International Monetary Fund (IMF). However, it is not clear that this is a superior strategy.
• •    The media has recently reported some economists responding to the suggestion of money financing with the Friedman-esque quip “there ain’t no free lunch”. 
• •    But it may be mentioned that there is no free lunch in the case of debt financing either. 
• •    Not only have the moneys to be repaid, they will have to be paid back in hard currency. This would involve India having to earn hard currency by stepping up exports. 
• •    If a stimulus of approximately 10% of the GDP is envisaged, with exports at 25% of the GDP, it would imply stepping up exports by close to 50%. This would be a herculean task under present circumstances. 
• •    Indian exports have been faring poorly since 2014. Since then, there have been multiple shocks to global output and trade.

 Issues with borrowing:

• •    Three more issues are relevant when considering borrowing from the World Bank and the IMF. 
• •    First, there is the issue of conditionalities. There is no reason to oppose conditionalities on principle but it is not obvious what conditionalities will come along with the loan. 
• •    Second, a loan is bound to take some time to be negotiated, taxing the energies of a government that ought to be engaged in the day to day battle with COVID-19. 
• •    Third, external debt is truly national which, arguably, government bonds held by the country’s private sector are not.
• •    The standard economic argument against money financing is that it is inflationary. 
• •    However, whether a fiscal expansion is inflationary or not is related more to the state of the economy than the medium of its financing. 
• •    When resources are unemployed, output may be expected to expand without inflation. 

 Conclusion:

• •    As COVID-19 has shocked output downwards, unemployed resources must now exist. 
• •    There is no reasoned case for denying ourselves the option of money financing to take us back to pre-COVID-19 levels of output and employment.

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Prelims Questions:

Q.1) With reference to the Modern Slavery, consider the following statements:
1. According to a report by Commonwealth Human Rights Initiative (CHRI) and an international anti-slavery organisation ‘Walk Free’ Commonwealth countries accounting for about 40% of people living in conditions of modern slavery in the world.
2. India, like all other Commonwealth countries in Asia, had not ratified the International Labour Organisation’s 2011 Domestic Workers Convention or the 2014 Forced Labour Protocol. 

Which of the statements given above is/are correct?
A.   1 only
B.   2 only
C.   Both 1 and 2
D.   None 

Answer: C

Mains Questions:
Q.1) What are the pros and cons of the debt financing and equity financing?