Government at the risk of facing an increased fiscal deficit in times of COVID-19

Since the COVID-19 patients have been discovered in India the onus lies on the central government on how to cope with this adversity. It has already imposed a lockdown of 21 days and whether to continue with this lockdown is its decision.

Two former governors of RBI, Raghuram Rajan, and Urjit Patel have come up with their views. As per Urjit Patel, India cannot do what developed economies are doing to stop the lack of demand caused due to the COVID-19 lockdown. He is worried about the impact on the macroeconomic stability of India of such policies. They can issue more cash into the economy but this can also cause inflation. Apart from an increase in inflation, if the government issues more cash into the economy, there will be an increase in fiscal deficit for the government. Pressure will be more on the state government because of the high spending if the central government faces a deficit. A high fiscal deficit could lead to high debt causing a fall in the value of the rupee. Urjit was the RBI governor till the time period of December 2018.

According to Patel “First, revenues will decline sharply; and, secondly, state governments who are the first responders of the health emergency will be hard pressed.” Mr. Patel was also quite vocal in his criticism about the dual policy followed by the government. On one hand, it was preventing imports through higher custom duties and also stopping the outward payments. Since it was stopping imports, this could lead to stability in the foreign exchange reserves of the government. The government was allowing foreign inflows into the capital markets of India. This would lead to lesser borrowing costs for the government.

It was not clear to Mr. Patel what was the current need for this strategy.

RBI was also following lax policies when it came to announcing NPA’s. The RBI was allowing banks to not categorize the MSME accounts as stressed accounts so that they could not be declared as NPAs. There was a delay in the announcement of NPA’s by banks. Last year, some 10 banks declared that their NPA’s were larger by an amount of 26,500 than previously announced for the last financial year. This kind of behavior could make an investment in this sector riskier. Apart from Mr. Urjit Patel was of the opinion that India needs to spend more in the times of COVID 19 outbreak, and take measures for larger testing, but this may or may not avoid lockdowns.

Mr. Raghuram Rajan is also of the same opinion as Mr. Patel. It needs to have more testing for this virus. According to Rajan ““Economically speaking, India is faced today with perhaps its greatest emergency since independence,”

Rajan was the governor of RBI from the years 2013 to 2016.

Rajan has advised that the government needs a lot of people and their support to deal with this crisis. Therefore, it also needs to seek people from the opposition who have dealt with this kind of crisis before. According to him, all the people from the PMO’s office are not sufficient to deal with this kind of situation. On the other hand, although the spending by the government needs to increase, the credit rating of the country can also go down due to an increased fiscal deficit.

According to Rajan, the rupee will face devaluation once the fiscal deficit increases and there will be an increase in the interest rates to attract more investors leading to losses for banks and financial institutions. Hence the ideal solution for the government in this time of crisis is to focus on important expenditures and cut down on unneeded ones.