[Editorial Analysis] Getting out of the ‘guns, germs and steel’ crisis

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

Context:

• India faces a “guns, germs and steel” crisis.

• There are Chinese “guns” on the borders. There are coronavirus “germs” in our bodies. There are “steel” makers and other businesses on the verge of bankruptcy.

• Arguably, this is the gravest confluence of military, health and economic crises threatening our nation in more than a generation.

• Each of these would qualify as an independent, large crisis by itself, warranting a specific resolution.

• The Chinese military threat calls for immediate and strategic action by our defence and foreign affairs establishments.

• The COVID-19 health epidemic is here to stay and needs constant monitoring by the Health Ministry and local administration.

• The economic collapse is an enormous challenge that needs to be overcome with prudent policy.

Standoff and Kargil Parallel:

• The common thread across these is that its resolution requires significant financial resources.

• Standing up to a military threat by a superpower neighbour will pose an inevitable drain on the finances of the government.

• India’s war against Pakistan in Kargil in May 1999 provides hints of the financial burden of a military threat.

• India’s defence expenditure in the war year shot up by nearly 20% from the previous year.

• It also forced the then government to increase India’s defence budget for the next financial year to 2.7% of nominal GDP, the highest in decades.

• China is a far mightier power than Pakistan. A portion of India’s land in Ladakh has been grabbed by China.

• Surely, India is bound to assert its rights, which will necessitate higher expenditure.

• India’s defence budget has been whittled down to just 2% of GDP for the financial year 2021. China’s defence budget is nearly four times larger.

• In all likelihood, the Chinese conflict will stretch central government finances by an additional 1-2% points of GDP, as India staves off the current threat and shores up its defence preparedness.

Healthcare and Economy:

• The health pandemic has exposed India’s woefully inadequate health infrastructure.

• The combined public health expenditure of States and the central government in India is a mere 1.5% of GDP, compared to China’s at 3% and America’s at 9%.

• Many public health experts are of the opinion that the central government will need additional funds of the equivalent of at least 1% of GDP to continue the fight against COVID-19.

• There is no option other than to significantly ramp up India’s health expenditure.

• India’s economy has four major drivers — people’s spending on consumption, government spending, investment and external trade.

• Spending by people is the largest contributor to India’s economic growth every year.

• The lockdown shut off people from spending for two full months, which will contract India’s economy for the first time in nearly five decades.

• Now, with the global economy in tatters, trade is not a viable alternative to offset the loss from consumption.

• Investment is also not a viable option at this stage since the demand for goods and services has fallen dramatically.

Incremental funds needed:

• The only options then are to either put money in the hands of the needy to stimulate immediate consumption or for the government to embark on a massive spending spree.

• Based on estimates of loss of consumption, incomes and its multiplier impact, government will need to inject incremental funds of 5% of GDP.

• Thus, India’s “guns, germs and steel” crisis will impose a total financial burden of an additional eight percentage points of GDP on the central government exchequer.

• Where will the government get such a large sum of money from?

• The government had expected a nominal GDP growth of 10% this year. It is clear now that GDP will not grow but shrink.

• Central government revenues for this year were budgeted at 10% of GDP which will not be achieved. Revenues will likely fall short by two percentage points of GDP.

• In sum, the government needs to spend an additional 8% of GDP while revenues will be lower by 2% of GDP, a combined gap of 10% of GDP.

• Potential new sources of revenue such as a wealth tax or a large capital gains tax are ideas worth exploring for the medium term but will not be of much immediate help.

The Junk Rating risk:

• The only option for the government to finance its needs is to borrow, which will obviously push up debt to ominous levels.

• When government debt rises dramatically, there will be a fourth dimension to the “guns, germs and steel crisis”; a “junk” crisis.

• With rising debt levels, international ratings agencies will likely downgrade India’s investment rating to “junk”, which will then trigger panic among foreign investors.

• India thus faces a tough “Dasharatha” dilemma — save the country’s borders, citizens and economy or prevent a “junk” rating.

Printing money:

• Some economists argue that there is a magical third choice – to simply print how much ever money the government needs to overcome these crises.

• Economic theory states that if money is printed at will, it can lead to a massive spike in prices and inflation.

• This theory has fallen flat in the past decade in developed nations such as America where the creation of phantom money has not led to inflation.

• Hence, the Reserve Bank of India can just create money at will and transfer them to government coffers electronically, is the argument.

Key issues:

• There are multiple problems with this argument. Printing will still be counted as government debt and not escape a potential downgrade to a “junk” rating.

• The U.S dollar, by virtue of being the world’s reserve currency, has an in-built protection against a currency crisis that can be triggered by at-will printing of money, that other developing nations such as India do not possess.

• If there were indeed no costs to printing money whenever governments need, then why tax citizens at all?

• Countries could just print money for all their expenses every year.

Conclusion:

• The magical third choice i.e. for the government to finance, it needs to borrow.

• It can give the Indian government the money it needs and, also prevent a ratings downgrade.

• The nation is at the precipice of an extremely challenging moment in her history.

• How India emerges from this crisis will shape not just India’s destiny but the world’s.

• The government’s choices are either to be bold and embark on a rescue mission, or do nothing and hope the situation resolves itself.

• On balance, it seems that the best course of action is to borrow unabashedly to pull India out of the “guns, germs and steel” crisis and deal with the consequences of a potential “junk” nation label.

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Prelims Questions:

Q.1) With reference to the International Day of the Celebration of the Solstice, consider the following statements:

1. International Day of the Celebration of the Solstice was observed on June 21.

2. A solstice is an event that occurs when the Sun reaches its most northerly or southerly day-arc relative to the equator.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: C

Mains Questions:

Q.1) To what extent the incremental funds are required to boosting our economy. Comment.

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