Bend with The Wind (Indian Express)

Mains Paper 3: Economy 
Prelims level: Taper tantrum
Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment

Context:

• Even a cursoryreading of Brazil’s recent history will confirm that the adoption of the all-encompassingcap on government spending in late 2016 was critical in rescuing the economy from the crisis of 2014-16.
• After riding the commodity boom of the 2000s, economic mismanagement and a series of corruption scandals pushed the country into an economic and political crisis in 2014-16, which ended the 14-year rule of the Workers Party (PT).
• During its rule, PT had implemented sweeping social programmes (such as Bolsa Familia) to reduce inequality and eradicatepoverty.
• Although contested, most assessments suggest that these programmes helped in improving living conditions (income, health, and education) of the poor.
• But with the end of the commodity boom, Brazil’s growth faltered and funding these programmes strained macroeconomic management, widened the fiscal deficit, and raised public debt.
• While the 2013 Taper Tantrum was the trigger, the ensuing economic recession, weighed down by corruption scandals, turned into a political crisis ending PT’s rule.
• Inflation, unemployment, and the fiscal deficit all jumped to double-digits.

Structural reforms:

• In an effort to regain policy credibility, the interim government proposed and passed a constitutional amendment in late 2016, which, starting from 2017, capped government expenditure.
• It excluded interest payments but included capital spending — to its 2016 level adjusted each year for the previous year’s inflation.
• This law effectively set a ceiling on government spending at around 20 per cent of GDP that can only be reviewed in 2026.
• While stringentby the standards of international fiscal rules (that are mostly in the form of restraints on fiscal deficit and public debt), it is almost draconian in the case of Brazil as more than 90% of its spending is mandated by law, leaving little room for even expenditure switching.
• The recovery from the crisis has been gradual, especially as most of the needed structural reforms (barring changes to the social security system) as promised by the new government elected in 2018 are yet to be legislated.
• But the spending cap set a transparent fiscal anchor that restored macroeconomic stability and in doing so helped to bring down inflation from over 10% in 2016 to around 2.5% and opened the space for policy interest rates to be cut from above 14% to 2% at present.
• Additional expenditure:
• Despite the demonstrated centrality of the spending cap in securing macroeconomic stability, the government allowed the spending cap to be breachedwith large pandemic-related additional expenditure.
• It included a generous income support, especially to the Bolsa-Familia households (roughly equivalent to BPL households in India), which alone can amount to over 4.5 per cent of GDP.
• Taken together, these measures will raise overall spending to above 28% of GDP and together with the revenue shortfall, will increase Brazil’s fiscal deficit from 6% of GDP in 2019 to an astounding 17% of GDP this year.
• And the additional spending has helped.
• Although Brazil’s COVID-19 infection rate was about the same as in India in the second quarter (in the last two months the rate has stabilised while that in India has continued to climb), GDP growth collapsed by 33.5 per cent, half of that in India.
• Indeed, at 67.2 per cent (annualised quarterly rate), the growth collapse in India was the second largest in the world next only to that in Peru.
• If one looks under the hood, public spending helped to offset some of the collapse in private demand in Brazil but in India it added to the decline.
• On the back of the continued income support, analysts have upgraded growth in Brazil while further downgrading it in India.

 Bending with the wind:

• All this discussion about Brazil’s economics is to underscore a simple point: There are times when policy needs to lean against and times when it has to bend with the wind.
• This is the time to do the latter. It isn’t that the market has been overly generous towards Brazil.
• In fact, at present there is palpable market angst about the Brazilian government’s budget plans for 2021.
• If the 2021 budget does not reverse the pandemic spending, the market will not take it kindly.
• The ensuing financial stress will likely unanchor inflationary expectations and force the central bank to raise rates despite the still fragile recovery.
• On the other hand, if the government brings spending below the cap, the attendant fiscal drag will be substantial.
• But the central bank can continue to keep interest rates low for longer and strengthen the private sector recovery in 2021 especially as balance sheets will be less damaged than otherwise because of the income support this year.
• And this is where the importance of income support lies.
• It is not so much that it has helped to support demand this year, but that it has protected, to varying degrees, household and SME balance sheets from the extensive damage the pandemic is likely to leave in its wake.
• Unlike typical EM crises, the pandemic is not an instance of a financial crisis turning into an economic shock because of damaged balance sheets.
• Instead, it is an economic shock brought on by the failure of the public-health system that can turn into a financial crisis if the damage is extensive.

Conclusion:

• In India, the debate over fiscal policy has been too focused on demand management.
• Income support or other government spending can help only modestly in compensating the collapse in private demand until the link between infection and mobility is broken.
• That’s a public health problem. Economic policy cannot compensate for the weaknesses in the public-health system.
• But appropriate economic measures now can have a much bigger and long-lasting impact when the pandemic has been brought under control and an economic recovery gets underway in earnest.
• What is needed is ample income support for households and firms now so that the recovery is not hamstrungby excessively damaged balance sheets.
• Otherwise, the pandemic can easily turn into a financial crisis, delaying the recovery and hurting medium-term growth.

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Prelims Questions:

Q.1) The Chushul sub-sector lies south of which of the following lakes?

Which of the statements given above is/are correct?
(a) Sheshnag 
(b) Tso Moriri
(c) Wular
(d) Pangong Tso

Answer: D

Mains Questions:

Q.1)What is needed is ample income support for households and firms now so that the recovery is not hamstrung by excessively damaged balance sheets? Comment.