MTP

SESSION 7

Reading
1. This set of slides / Class notes
2. From the Blanchard:
Chapter-3 - The goods market
 5 ways…..
Taxes
reduces AD, defeats purpose of fiscal policy
Disinvestment of Public Sector Assets
Not a regular source of finance form the government.
Reduces Budget deficit for the year. Cannot be repeated every year.

Financing the Borrowing from domestic citizens

adds to governments burden on interest payment
budget Borrowing from foreign citizens
causes drain of foreign exchange on interest payment
Monetisation of deficit
Borrowing from central bank
This has implications similar to a
printing money monetary expansion.
increases money supply Þ Inflation and devaluation of
currency
Þ Economic fundamentals fall
Þ Credit ratings fall

https://economictimes.indiatimes.com/markets/stocks/news/deficit-monetisation-is-it-really-as-
simple-as-rbi-printing-more-money/articleshow/75968757.cms?from=mdr
India’s Fiscal Stimulus 2020
Total stimulus package of Rs 29.87 Lac Cr.
Value of COVID-19 fiscal stimulus packages in G20 countries as of October 2020, as a share of GDP

25%

21.1%
20%
Value of fiscal stimulus measures as a share of GDP

16.4%

15% 14%
13.2% 12.8%
12%

10% 8.9%
7% 6.9%
6% 6%
4.9% 4.4%
5% 4.3%
3.4% 3.4%

0.7%
0%
a ** s* ey il * a * ce a ly ia * ia ia
pa
n
ad ia te rk az ** in ** in Ita es ** ss b ico
Ja n l a u Br y h * an nt n * u ra ex
Ca st
ra St T an C
di
a Fr g e
d o n* R i A M
u ed rm In Ar In i o ud
A it Ge Un Sa
Un n
p ea
ro
Eu

Note: Worldwide; as of October 9, 2020

Further information regarding this statistic can be found on page 8.
Source(s): IMF; ID 1107572
Tranche 1 – Rs.5.9 Lac Cr Tranche 4 and 5 – Rs.48,100 Cr
1. Rs.3 Lac Cr collateral free loan to MSMEs On Air space infrastructure
2. Rs 50,000 crore equity infusion for MSMEs
On mining and coal sectors
3. Rs.1.2 Lac Cr liquidity relief measures for
NBFCs housing finance Cos. and power MGNREGA allocation
distribution companies… etc.

November 2020 – Rs.2.65 Lac Cr

Tranche 2 – Rs.3.1 Lac Cr
On manufacturing sector support
1. Rs.5000 Cr credit facility for street venders
On fertilizer subsidy
2. Rs. 2 Lac Cr – Kisan Credit
On housing, infrastructure, rural employment,
3. Rs.11,000 Cr – food and shelter facilities for COVID R&D etc…..
migrant workers

RBI measures - Rs.12.71 Lac Cr liquidity measures

Tranche 3 – Rs.1.5 Lac Cr
Earlier Measures – Rs. 1.92 Lac Cr
1. Rs.1 Lac Cr post harvest agri infrastructure
2. Rs.50,000 Cr for development of various
agricultural subsectors
Fiscal stimulus should be distinguished from

• Credit
Credit is not fiscal stimulus. Credits will flow back to the government.
Taking a loan is voluntary. Entrepreneurs take loans only if they foresee profitability. Thus
all the credit offered by govt. may not flow out to the market.

• Equity infusion
Again equity infusion is not fiscal stimulus. Equity fund will flow back to the government.

• Liquidity relief measures for NBFCs, housing finance companies

This will partly solve the liquidity crunch with the NBFCs.
Hopefully credit will flow to businesses. But its not fiscal stimulus.

• RBI liquidity measures

This is not a fiscal stimulus.
This will increase money supply or liquidity in the market. But, with supply bottle neck during
the pandemic, may cause prices to rise.
 Government increases the proportional income tax of
10% to 20%. Should this affect the aggregate income? Or Its
Effect of tax growth (multiplier)?

on the How?

multiplier Instead on an income tax, government imposes a lump

sum tax, where every citizen pays a tax of Rs.1000 per year.
Does it affect the aggregate income or its growth?
 Say, the govt. has imposed a proportional income
tax, such that
T = t . Y Should this raise GDP faster?

C = a + c . Yd = a + c (Y – tY)
Effect of Yd = disposable income = (Y – tY)
AD = a + Io + Go + c (Y – tY)
income tax on AS = Y
the multiplier Equilibrium income = [a + Io + Go] / [ 1 – c(1-t) ]

Government Expenditure Multiplier with

proportional income tax
= 1/ [ 1 – c(1-t) ]
 Value of the multiplier for Govt.
expenditure if the tax is lump sum and
not proportional to income.
Effect of lump
sum tax on the C = a + c (Y – T)
multiplier
Equilibrium Y* = (a-cT+Io+Go) / (1-c)

Multiplier : 1/(1-c)
 India’s Govt. Budget Deficit as % of GDP

Budget Deficit

For India’s fiscal performance relative to emerging market countries see:

https://www.livemint.com/news/india/india-s-fiscal-performance-in-nine-charts-11581
857139177.html
https://www.financialexpress.com/economy/indias-fiscal-deficit-may-climb-to-7-6-of-
gdp-in-fy21-economy-likely-to-contract-this-much-in-q2/2085557/
 Budget deficit
= G + TR + subsidies + int. payment – Tax
collected – disinvestment (if any)
= G – T + interest payment

Budget deficit We write G instead of (G+TR+ subsidies)

since all three are expenditures from the
and growth government’s point of view.
We write T in place to Tax collected +
disinvestment income, since disinvestment
income is not a regular phenomenon.

What happens to budget deficit if

government expenditure increases?
G↑ → BD ↑

G↑ → AD ↑ → Y ↑ → Tax collection ↑ → BD
↓

So, does BD rise or fall if G rises?

Exercise

What happens to budget deficit if government expenditure

increases by Rs. 10 Cr.?

Given :
Proportional income tax of 20%
Marginal propensity to consume = .6
Change in BD = ΔG - ΔT
T = t.y
ΔT = t. ΔY
= t. ΔG. [ΔY/ ΔG]
= t. ΔG. [multiplier]
= t. ΔG. [1]/ [1-c(1-t)]

Change in BD = ΔG - ΔT
= ΔG. [(1-t)(1-c)] / [1-c(1-t)] > 0

So BD will increase if there is an increase in G by a fraction of increase in

G.
 Enhanced government expenditure increases
output
Increased taxes cause decrease in output
Is budget
deficit
Is it possible to affect output if budget is balanced,
necessary to that is if G and T increases equally?
increase
output?
Or is a budget deficit necessary to raise output?
In equilibrium AD = AS
Y = a + c (Y – T) + I + G

Y* = [a + I + G - cT]/[1 – c]

ΔY / ΔG = 1 / (1 – c)
ΔY / ΔT = -c/(1-c)
Therefore, change in Y when both G and T increases
= ΔY = [ΔY / ΔG]ΔG + [ΔY / ΔT]ΔT
= ΔG /(1-c) – cΔT/ (1-c) [When budget is balanced, ΔG = ΔT]
= ΔG = ΔT
Therefore [ΔY / ΔG] = [ΔY / ΔT] = 1
Balanced Budget multiplier = 1
Thus, even when budget is balanced, increased G increases output.
But this increase is less than the case when only G increases or G increases
more than T.

Reason:

Only G ↑ → AD↑ more than in proportion

only T ↑ → AD ↓ but only c frantion of the disposable income is lost from the
aggregate demand.
Therefore overall AD ↑, when G and T increases equally.

This AD↑ is less than the case when only G rises, without a matching tax
collection. Tax has a dampening effect on the consumption expenditure.
http://youtu.be/ysO_ELCZ50
8

http://youtu.be/CyW5EPiP0x
l

http://youtu.be/2L9upCVo2S
g

National Monetisation Pipeline 2022-

25
 Public sector assets will be leased out to private players,
domestic and foreign.

Ownership will remain with the government.

The plan There will be a mandatory hand back after 25-30 years.

During the lease period the private sector will carry out the
operations, earn revenue and share the revenue with the
government.
Ideal
scenario Build new physical
assets /
Govt.
infrastructure
Lea
and se mo
sha reven ney
re ue

Loans
Bank Pvt.
s firms
What is
Pay ba Generate
Sa

Taxpayer’s nk loa likely to

v

money ns revenue
in
g

happen
s

an ks Govt.
tb Lea
u and se mo
People il o
Ba sha reven ney
re ue

Loans
Bank Pvt.
s firms

Sa
Taxpayer’s Generate

v in
money revenue but

gs
Build NPAs not payback
for Banks the banks
People
 Massive human resource capacity is required to

Is is possible 1. design the contracts

2. bidding the projects to an efficient value
to 3. monitoring to make sure that the contracts are implemented as
designed.
implement But government does not have that big a recourse capacity.

the NMP? Therefore, the NMP will possibly not be implemented in the
proposed big scale.
 Will the private sector invest?
Consumer confidence has fallen drastically
India’s

Will the
Consumer
confidence
index
private 2011-21

sector come
forward to Capacity utilization has fallen India’s

invest? Capacity
utilization
2011-21

why would private sector be inclined to invest?

 1. In this time of recession, income streams from the public assets
have come down.
=> valuation of these assets will be low
=> government will receive very little money as lease
Therefore, it is not the right time to lease the public sector assets.
It is not the
right time to
privatise 2. Private sector is highly likely to cut down employment for
efficient operation
Unemployment levels are already high.
Therefore it is not the right time to privatise.
 1. The public sector assets may be leased out to favourites of the
current government, to those who contribute most to their
electroral funds.
That is the observation from the privatization of airports.
=> concentration of wealth in the hands of a few corporate giants

Future of
=> rise of oligarchy

the markets
2. Leasing out only for 25 years
=> the private sector will only think of a 25 year time horizon, not
about the long run future of the PSUs.
=> Asset stripping possible