Fiscal stimuli, monetary loosening, Quantitative Easing (QE), suspension of bankruptcy laws and many more – governments around the worlds are firing heavy weapons to tackle the ongoing economic recession and India is no exception. With budget around the corner, “another round of big fiscal bonanza” is the only talk in the town! No doubt, fiscal spending is the need of the hour, and finance minister has already given indications that this will be a historic budget from fiscal standpoint. However, the other big theme developing in India is “uncertainty”! And I am not talking about uncertainty about how the pandemic will shape up but uncertainty about reforms.
The protests against farm laws have not only created uncertainty about farm reforms but could have far reaching implications beyond agricultural sector. The fact that implementation of progressive farm reforms which are recently hailed even by IMF is getting delayed has created a sort of “reforms uncertainty” in the minds of investors and companies. The Economic Policy Uncertainty (EPU) index developed by Scott Baker, Nicoloas Bloom and Steven Davis showed a big increase from 82 to 95 from September to October when protests against farm bills started to take shape. This rise in EPU was despite the fact that pandemic spread was easing in India as well as corporate India volumes and other high-frequency indicators were showing signs of recovery, indicating that this rise was mainly due to Farm protests.
The only yardstick sometimes used to gauge how “big” the stimulus is to look at the direct spending. For example, economists and opposition parties pointed out that majority of stimulus announced early in the pandemic was in the form of bank guarantees. But sometimes, that is exactly what markets require. When markets/banks are flushed with liquidity, may be government need not spend huge on its own. It needs to take credit risk off-the-table from markets to not let sentiments and uncertainty drag the credit growth. That’s exactly what government did in the early rounds. The targeted support to rural economy is generating good rural demand (for example two-wheelers and paints just to give an example) and at least a part of this increased rural spending has to do with the confidence that rural consumers have developed about continued support. Hence, fiscal policy is as much about sentiments and managing confidence as it is about actual spending.
The fiscal or monetary support multiplies in the economy (the so -called “fiscal multiplier”) only when companies, individuals, and international investors act upon it. But heaps of evidence shows that companies and investors turn cautious when legal and reform uncertainty ramps up. For example, Brandon Julio and co-authors in their article titled “Political Uncertainty and Corporate Investment Cycle” have convincingly shown that corporate capex falls before the elections and more so if the election is likely to be close.
Studying 16 episodes of uncertainty (such as Cuban Missile Crises, Oil Shock etc.) Nicolas Bloom and his co-authors have convincingly shown that firms “wait and see” – they hire fewer employees, invest less in machines, consumers spend less on durables like TV and cars. Boyan Jovanovic and Sai Ma of Board of Governors, Federal Reserve in their 2020 paper show that higher economic and political uncertainty can cause growth to falter and economy to become more volatile over next three years. Most importantly, international investors (mutual funds, pensions) fly to safety as policy uncertainty rises and especially in the emerging markets. This was evident not only during 2008 crises but also during COVID.
There is palpable risk that farm risk can turn out to be a trigger point for this build-up in the uncertainty around the country especially when coupled with background of say slow progress on disinvestments of PSU’s, even if attributable to weak investment environment caused by pandemic, or legal battles in the Telco sector. When the government will talk about next reform, will investors not have doubts in the mind about “implementation risk”?
Therefore, it is important for the government to focus on clearing the pipeline of proposals and reforms, even some smaller ones, in a quick succession and not let this sentiment of uncertainty cripple the well-fought battle against the pandemic. The impact of the well-targeted stimuli will transmit better to the economy when investors are again confident about the reforms.
Lastly, there will be lot of uncertainty about how the government will fund the growing fiscal gap in the coming years. However, this should not deter government from using fiscal force, especially given that the yields are at the lower end. What can assuage the markets and investors though is a clear path and policy direction regarding the borrowing schedule and sources of funding.
Bridging the information gap cannot be more important than ever!
Views expressed above are the author’s own.
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