The rapid slowdown of the global economy consequent on the intensification of the one-year-old financial crisis since the middle of September has posed extraordinary challenges for economic policy-makers everywhere. Recessionary trends already in evidence in the United States and other developed countries were aggravated by the severe liquidity crisis that set in following the failure of mainline banks in the U.S. In India, the liquidity crisis has defied substantial cash infusions made primarily through CRR reductions. Policy interest rates were brought down sharply. Despite these interventions and persuasion by the government, interest rates remain sticky mainly because in situations such as these, where there is great financial stress, monetary transmission is bound to be imperfect. Besides, inflation is yet to be reined in. If the global slowdown resulted in lower exports, there has been a decline in domestic consumption and investment demand too. The overriding lesson is that monetary measures can only be a part of the solution to the complex economic problem of the day.
Fiscal measures to stimulate the slowing economies are the flavour of the season. At the recent Washington summit, leaders of 20 countries agreed to stimulate their economies through synchronised fiscal boosts. The U.S. announced an $800 billion package. China plans to spend in a time-bound manner nearly $600 billion on a variety of infrastructure projects and nation-building activities. In India, however, the Prime Minister has implied that a fiscal stimulus package is in operation. In October, the government submitted the largest ever supplementary demand for grants totalling Rs. 237,286 crore, a 33 per cent increase over budget estimates. A bulk of this money will go towards pay rise for government servants, higher allocation for the National Rural Employment Guarantee Programme, and farm loan waiver. As a consequence of this huge extra expenditure, the budgeted central deficit including the off-budget items is estimated to go up to 7 per cent of the GDP in 2008-09. In the recent period, fiscal stimulus rather than fiscal rectitude has become the desirable policy option. It needs emphasis, however, that uncontrolled expenditure on non-essential areas cannot serve as a meaningful fiscal stimulus. What is needed is a well thought out spending package that focusses on building physical infrastructure and strengthening the infrastructure in areas such as education and health.