The trade-off between the size of welfare state and macroeconomic credentials.
By Sukumar Vellakkal
Moody’s has downgraded India’s sovereign rating to the lowest investment grade score of Baa3, with negative outlook. This is now at par with ratings by Fitch and S&P. The potential reason for this downgrading is the anticipated negative effects, mostly due to Covid-19, on macroeconomic fundamentals including decline in GDP growth and expanding fiscal deficit. However, this downgrading happened a few days after the government’s announcement of economic stimulus package to increase the availability of funds to revive GDP growth by boosting aggregate demand.
Moody’s downgrading is going to put more pressure on the government to concentrate on strategies of promoting GDP growth, and tightening of any fiscal deficit widening redistributive and welfare fiscal measures. This would be at the cost of social and development indicators of the country.
Adverse effect on social indicators
Of the total Covid-19 economic stimulus, notably the fiscal components were just around 1% of GDP. Of this, only two-third was for immediate relief to individuals struggling for subsistence that includes additional resource allocation to rural employment (MGNREGA), the PDS and other related welfare programmes for the weaker sections. Several countries, including many East Asian ones, responded to their Covid-19 crisis with fiscal stimulus of more than 10% of GDP.
As the pandemic is taking the country to an unprecedented economic and social crisis, such a low level of fiscal stimulus is not justified. The crisis, along with the long national lockdown and its aftermath, has been hitting most sections of the population. The worst affected are those who belong to the informal sector, especially casual labourers seeking employment on a daily basis. The immediate and direct effect of the crisis is on unemployment and subsequently on food insecurity and poverty for millions of households. Women and children are going to be more vulnerable to severe food insecurity, as historically they have been. Because of social distancing and lockdown, the mid-day meal schemes are also inoperative, exposing more number of children to malnutrition.
These all would threaten the social and development indicators of the country, and especially the UN’s first three SDGs—End poverty, End hunger and Ensure healthy lives. Even before the pandemic, as per the 2017 Global Hunger Index report, India is home to over one-third of world’s malnourished children. According to the latest 2015-16 NFHS report, 58% of the children under the age of five are anaemic, 38% are stunted (short-for-their age) and 36% are underweight (thin-for-their age). In addition, infant mortality was 41 and neonatal mortality was 30 per 1,000 live births, which is also much higher than the average of developing countries. Moreover, the access to maternal and child health services of the vulnerable population groups would decline due to the deepening crisis and prioritisation of Covid-19 care over other health services.
Maintaining macroeconomic credentials at the cost of social sector
It seems the government is concerned that financing such a huge fiscal stimulus would jeopardise macroeconomic fundamentals, and would further deepen the crisis. As the projected fiscal deficit (i.e. the borrowing requirement of the government) is at 3.5% of GDP in the Union Budget 2020-21, the deficit is going to increase because of shrinking GDP and subsequent depletion in government revenue. In this context, financing a huge fiscal stimulus through borrowing from the bond market would not only widen the fiscal deficit but also threaten other macroeconomic fundamentals. In addition to increase in the debt-GDP ratio, increased government borrowing will raise the market rate of interest, making future government borrowings costly, and the high rate of interest discouraging private investment.
Another option of financing the fiscal stimulus, rather than borrowing from the market, is RBI printing more money to ‘monetise the budget deficit’. However, there is a risk of increasing inflationary pressure in the economy. Thus, the expanding fiscal deficit along with other weak macroeconomic indicators would lead to further downgrading of India’s sovereign rating by rating agencies.
With its economic stimulus package, the government took the path of reviving GDP growth by its liquidity programme and neglected the fiscal package for the weaker sections of the society due to the fear of expanding fiscal deficit. Even after doing this, Moody’s downgraded India’s ratings. Any further downgrading would slip India’s ratings into ‘non-investment speculative grade’. This would lead to decline in foreign investment with decline in net capital inflow, and risk the exchange rate as well. In the coming days, Moody’s downgrading is going to put more pressure on the government to concentrate on strategies of promoting GDP growth, and tightening of any fiscal deficit widening redistributive and welfare fiscal measures.
As the size of the economic crisis is vast and the sovereign rating is already at a lower level, it is natural the government is concerned about macroeconomic fundamentals. However, sound social and development indicators are also the backbone of the country. A healthy population can significantly contribute to the nation’s economic growth, thus policy interventions for ensuring employment, and universal access to affordable and quality food are vital. Allocating additional resources are required to address the immediate problems of food insecurity and unemployment.
There is also a need to pump more money into the MGNREGA and reorient the programme for nation-building infrastructure. Given that our agriculture sector is doing well now and forex reserves are strong, policymakers need to consider various strategies for pumping additional resources into welfare social programmes, without compromising macroeconomic fundamentals. Some sectoral and programme reallocation needs to be considered for finding alternative fiscal resources for financing the social programmes.
The author, a public and social policy researcher, teaches macroeconomics and financial economics at BITS Pilani Goa campus. Views are personal