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FINANCIAL STABILITY AND ECONOMICFINANCIAL STABILITY AND ECONOMICFINANCIAL STABILITY AND ECONOMICFINANCIAL STABILITY AND ECONOMIC

STIMULUS PACKAGESTIMULUS PACKAGESTIMULUS PACKAGESTIMULUS PACKAGE....

Prof. S. Moharana

Director MFC,

Department of Commerce

Utkal University

Financial Stability is considered to be the prime requisite for the accelerated and

sustained economic development of a nation. The period from 2006-07 to 2008-09 was

marked by the global financial instability of a magnitude not noticed since the 1930s great

depression. The financial meltdown which started in the developed economies of the worldled by USA spreaded its tentacles to the developing and under developed economies. Indian

economy experienced some amount of financial and economic instability including lower

economic growth rate during the initial two years but due to a conservative economic policy

of the government and comparatively lesser dependence of the real sector of the economy on

the external market, the adverse impact did not continue for a long time.

No welfare government can afford to allow the financial instability to continue for a

long time. The financial instability at the macro level leads to bank runs and banking panics,

security market instability, price level instability, currency instability, house hold debt crisis,

corporate financial crisis and in extreme case sovereign debt crisis. There are cases when

financial instability also leads to political instability. The greater the size of the economy,

higher will be the destabilising impact of financial instability. The higher the linkage of the

domestic economy with the global economy, faster will be the pace at which the financial

crisis will spread from one sector to another and from one economy to another.

Financial instability when accompanies by real sector crisis becomes very difficult to

control. The traditional fire fighting tools available with the government, namely the

monetary and fiscal policy instruments have always proved to be ineffective. The approach

needs to be an integrated one with the combination of monetary policy, fiscal policy and trade

related measures. More important is the innovation and non conventional approach to fight

the economic crisis.

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In the aftermath of the global financial crisis, like most other countries of the world,

Indian government also announced a number of measures to shield the economy from the

global crisis and to minimise its adverse impact. One type of measures was intended toward

ensuring adequate liquidity in the economy. This includes the reduction in CRR, repo rate,

etc which led to huge increases in the liquidity in the system. The second type of measures

includes reduction in the Cenvat (from 14% to 8%) and Service tax (from 10% to 8%), which

were aimed at the making production less costly and marketing move competitive in the

recession affected world. The Government also increased its planned expenditures on

different heads to improve the infrastructural facilities and more importantly increase the

purchasing power in the hands of the consumer.

The total cost of the economic stimulus packages is estimated at more than Rs. 4 Lakh

Crores accounting for nearly 3 pc of the GDP. The fiscal deficit went up from 2.5pc of GDP

in 2007-08 to around 6.8pc during 2009-10 which is the highest in the last 16 year. The Govt

had a target of borrowing Rs 4.9 Lakh Crores during 2009-10 of which 85% is already

exhausted till the first week of January 2010. The crowding out effect of huge Government.

Borrowing has increased the cost of funds for the private corporate sector leading to slow

down of the investment activities. It also increased the yield on Govt. Bonds which has gone

up to 8pc by January 2010 end. The inflation is already at a record high level. The higher

inflation weakens the currency and depresses the growth. The persistent high borrowing of

Government has increased the debt servicing obligation. During 2009-10, the interestpayment as a percentage of revenue receipt is as high as 36.7pc. A higher interest burden eats

up a large portion of Govt. Revenues leaving less for productive expenditure.

Just before the presentation of budget in the parliament on 27th

of February, there is

increased debate going on in the intellectual circle both in the print and visual media, whether

it is advisable for the Govt. to withdraw the economic stimulus package announced at

different stages which has resulted in huge loss of revenue for the government.

There are apprehensions in the minds of the economists and policy makers thatimmediate withdrawal of stimulus package will lead to a severe blow to the slow revival

process that is already noticed in the economy. The Government is in a catch 22 situation. If

the economic stimulus package is allowed to continue, fiscal consolidation which is so

important for economic and financial stability will be difficult to achieve. Further, the

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government cannot allow it to continue due to its adverse impact on the revenue side, Govt.

Borrowings and on fiscal deficit.

While any abrupt withdrawal of the package is not advisable, a gradual withdrawal

will always be in the greater interest of the economy. It is my personal belief that to make the

Indian Corporate sector competitive in the international economy, the Govt. Should go in for

phased withdrawal of the economic stimulus package. The continuance of the package for a

long period will lead to a dependency syndrome among the corporate sector. This was very

much apparent during the period of controlled and regulated economic regime in India in the

pre liberalisation period.

At present, there is a positive trend in the growth rate of government revenue, exports,

imports, outputs both in .manufacturing sector as also in the services sector. Due to arbitrage,

huge amount of foreign investment is flowing to Indian economy prompting the RBI

Governor to indicate the possibility of imposing capital control. In the near future,

Government may also go for selected disinvestment in PSUs and 3G auction which will

result in a significant increase in the revenue and lowering of fiscal deficit. The health of the

banking sector in India can be considered to be very sound in spite of the requirement of

more capital to shore up their capital base. Not a single bank needed bail out support from the

Government. The security market is showing signs of stability. The investment activity is

slowly getting revived. The only concern for the Government is huge liquidity in the system

both in the banking sector also in the corporate sector. The Corporate are not taking any

aggressive steps for capital investment waiting for more stability in the domestic and global

market. The price level instability is posing the greatest .threat to the Government. The

increase in commodity prices is something which does not have a short term solution. The

general trend in the prices at the global market, increasing demand from consumers and a

near stagnancy in growth of domestic production in agriculture might have contributed to this

crisis. It needs a long tern approach and it is in the interest of the Government to seriously

look at this problem.

To conclude, I strongly feel that Govt. should withdraw the economic stimulus

package in a phased manner by closely monitoring its impact on the economy. It is possible

that the withdrawal may invite oppositions from industrialists and so called welfare

economists. But this is a cost which we need to bear to enable the long term sustainability of

the economic growth and to achieve a healthy and efficient financial system.