₹20 Trillion Economic Package Announced – All your questions answered!
Prime Minister Narendra Modi announced a massive package of Rs. 20 lakh crore to revive the economy from the COVID – 19 pandemic. It focuses on making India “Self Reliant” and for that five pillars – Economy, Infrastructure, Technology System, Demography, and Demand would hold great importance. The quantum of the package is nearly 10% of India’s GDP. While the details over the package would be announced by the Finance Minister in the coming days, there are several questions that we plan to answer in this article.
First and the big question where will the money come from?
The Indian government has already been running a high deficit which has become worse post-COVID-19 pandemic due to lower tax collections. And now we are in such a scenario where the government is required to spend more to keep the economic health intact. Therefore, in such a scenario the governments usually resort to their central bank and borrow more to spend and get the economy back on track.
How is it done?
The government issues a bond or series of bonds to the RBI at a pre-decided interest rate and tenure which RBI buys.
Where does the RBI gets the money from?
Well, they print (Didn’t we learn this in high school). This has become a common phenomenon and governments across the globe have done it in the past and continue to do so till today. They borrow from their central bank in times like these to keep the economy on track. Remember Quantitative Easing!
If printing is the solution, why don’t we always keep printing the money?
It’s not that easy. Consider this, printing money increases the supply of money in the system. That means more money is now chasing the same amount of goods which leads to price increase i.e higher inflation. To make it simpler, if you have Rs. 1,00,000 and suppose the government gives you an additional Rs. 10,000 (either by reducing taxes or additional income), wouldn’t you spend slightly more than you used to in a normal economic scenario. Therefore, for the overall economy, if everyone spends that extra money, the aggregate demand for products and services would increase which will increase the prices leading to inflation.
Why are we doing it if it will lead to inflation?
Let’s recap a bit, we have mentioned above that if you get the higher income you would spend more in a “NORMAL” economic scenario. But are we living in normal conditions? Hell No. We are living in possibly one of the most trying times at least in recent decades. Coming to inflation, it is unlikely that we would see a spike in inflation because of two main reasons, a) disinflationary pressure is huge as commodity prices worldwide have practically crashed which would keep the inflation under control, b) Secondly, it is not going to lead to a sharp surge in demand which in hindsight could have happened in the normal economic scenario.
In these uncertain times wherein there is no clarity on how long will this pandemic lasts, it is unlikely that people would think about spending, rather people would focus on building its savings to be prepared for any unforeseen scenarios. That means people would save more in their banks. Now banks would have higher Saving/Fixed deposits with themselves for which they would have to pay interest. To earn that interest, they would either lend it to companies/individuals (which is less likely as banks would remain extremely cautious in these trying times) or the other option is that they park their funds with the RBI and earn nominal interest (Reverse Repo).
Government still has to pay the debt
Remember, RBI was the one who started this cycle of lending the money and at the end of it, the central bank would have received a decent amount back which is not circulating in the economy and therefore would not lead to inflationary pressure.
However, one must note that the government would have to still pay this debt to the RBI. That too by not just borrowing like it plans to do now. It has to earn higher taxes to keep servicing this debt which will happen if the economy is up and running. Or it would have to keep borrowing more to service the debt. This is a vicious cycle and could potentially lead to rating downgrade or even default. India Sovereign rating is currently is just a notch above junk grade.
To conclude, well difficult times call for bold measures and that is what the government has intended to do. It will have repercussions (every policy does) but at this point increasing spending and reviving the economy outweighs them. The important thing is to come back to the fiscal consolidation path in the medium term.
We would be covering this story actively. Do Share and Subscribe!
Want to read more? Click here