Rollback of Stimulus

Topic: Rollback of Stimulus: A Risk or need?
Members Name: Himanshu Mehra
Amitabh Vatsya
Email Ids: [email protected]
[email protected]
Contact Nos: Himanshu Mehra – 9833880535
Amitabh Vatsya - 9619569674
Course Name: PGDIM
Institute Name: NITIE

Rollback of Stimulus: A Risk or need?
Abstract
The global economic meltdown required a massive boost from the government to get the wheels of the economy
rolling again. With the economies of various nations coming back on the growth path, the need arises for a
planned implementation of a rollback of the stimulus. Even with the reduction in systemic risks there still are
significant risks due to global liquidity levels combined with the absorptive capacities of the economy A phased
rollback of the stimulus is essential to maintain a balance between delivering sustainable growth and stabilizing
the economy. . The need for regulation in the financial markets is also felt throughout the world universally.
Thus there needs to be a concerted effort amongst various nations as well as between the fiscal and monetary
policies of individual countries to combat the risks involved in a vulnerable market economy.
“The good news is that we may be at the end of a free fall. The rate of economic decline has
slowed. The bottom may be near – perhaps by the end of the year. But that does not mean that
the global economy is set for a robust recovery any time soon. Hitting bottom is no reason to
abandon the strong measures that have been taken to revive the global economy”.-Joseph
Stiglitz (in “Stimulate or Die” dated 8 Dec 2009)
Economics defines business cycles as economy-wide fluctuations in production or economic

activity over several months or years. It includes periods of rapid growth and those of relative
stagnation as well. The world economy is on a revival path from the huge contraction that it
suffered due to the subprime crisis. As the credit crunch gripped the entire financial system, the
central banks moved in unison to avert further deepening of the recession by injecting liquidity
into the system. These stimulus packages have provided crutches to the crippled world economy.
But these crutches come with a caveat , the longer that you hold on to these crutches the more
you get used to them and the lesser become your chances of standing up on your own. This
analogy applies to the stimulus packages as well. The government needs to return to a path of
fiscal consolidation to avert dire circumstances like hyperinflation which have the potential to
ruin a perfectly healthy economy.
Stimulus Packages across nations
The size of stimulus has varied significantly

across nations. Including the measures
undertaken in 2008, the U.S. stimulus is largest
(a cumulative 4.8 percent of GDP during 2008–
10), while Italy and India are at the lower end of
the spectrum. Two sets of factors help explain
the relative size of stimulus packages:
(i) differences across countries in the need for
stimulus; and (ii) differences in fiscal space.
Source: IMF database & 2010 forecast
Countries in which the automatic stabilizers are larger need smaller discretionary stimulus.
Government size is a proxy for the impact of automatic stabilizers and is smaller in China, India,
the U.S., Canada, and Japan, and it is negatively related to the fiscal stimulus.
Growth impacts and needs
Stimulus efforts, together with the impact of the automatic stabilizers, provide an important
boost to growth and help forestall a negative downward spiral. According to IMF Preliminary
staff estimate, fiscal policy may have contributed 2–2½ % points to PPP-weighted growth of the
nine countries in 2008 and may provide 2–2¼ % points in 2009 and ¼–½ % points in 2010.The
decreasing impact of fiscal stimulus is indication for the rollback of stimulus worldwide.
A rollback of stimulus is necessary to bring the economy back to its natural growth path. This
artificial growth is not sustainable in the long run and needs to be dealt with on priority. The
global markets are upbeat on the magical carpet of the stimulus packages, but the real test for
these economies would be when they would be left all alone ,high and dry, in mid air. The action
plan should now involve a gradual and judicious withdrawal of the stimulus package as any sort
of misconceived notion of a V shaped recovery will be disastrous to say the least. The central
banks need to work on their strategies to maneuver themselves on this tight rope with the help of
an effective monetary policy.
Risk Analysis
The systemic risks have been substantially reduced following unprecedented policy actions and
nascent signs of improvement in the economy. Even with the momentum significant risks
remain. These are as follows:
 The recovery is driven largely by government spending in many economies

 Commodity and asset prices have risen aided by high levels of global liquidity
 Emerging market economies which are generally recovering faster than advanced
economies, are likely to face increased inflationary pressures
 Uncertainty about the pace and shape of the global recovery
 The surge in oil prices, if global recovery is stronger than expected
 Sharp increase in capital flows, above the absorptive capacity of the economy, which
may complicate exchange rate and monetary management
 Large fiscal deficits command a bigger risk to both short-term and to medium-term
economic prospects
Global Scenario
Last five year the world has seen a dramatic downside in term of negative growth in their
domestic products. All the major economies except China and India have undergone contraction
varying from -2.5% (France) to -10.2 % (Brazil) during 2009, as evident from the chart.
15
10
5
2005
0 2006
1 2 3 4 5 6 7 8 9 2007
-5
2008
-10 2009
-15
Chart: GDP Growth rate of major economies in last 5 years
1 France
2 Germany
3 Japan
The IMF says that, led by China, the world economy is bouncing back strongly from its 4 UK
5 US
2009 decline. US growth is projected to reach 2.7% this year, a nice rebound from last
6 India
year's 2.5% decline. The IMF, in its latest financial stability report, says there is an 7 China
urgent need for more regulation of financial institutions. 8 Brazil
9 Russia
Source: Global Financial Stability Report Oct 2009, IMF
This entire fiscal stimulus comes at the price of greatly expanded debt. The Congressional
Budget Office this week said the US deficit will for the second straight year exceed $1 trillion,
an amount equal to about 10% of GDP. This explosive volume of debt will at some point have to
be halted and rolled back. But, says the IMF, not yet. The exit from stimulus towards fiscal
balance should come only when there is a tangible pickup in consumption, investment and
exports. Unfortunately none of these elements are yet present.
Indian Scenario
The economy is steadily gaining momentum, though public expenditure continues to play a
dominant role, and performance across sectors is uneven, suggesting that recovery is yet to
become sufficiently broad-based. The baseline projection for GDP growth for 2009-10 is now
raised to 7.5 per cent.
The Industrial Growth in India has been

significant with 7.6% growth rate up to 3rd Q
and 11.7% in November but the closest
indicator of Industrial growth, bank credit
has not exhibited a parallel picture. Growth
in Bank credit is sluggish at 8.8% for the
first 3 Q of year as against 12.5% last year.
This can be due to either low demand of
funds from industry or the banks are not
lending easily.
Industrial Growth has been high at 6.3% but according to a recent study of 1752 manufacturing
firms, done by RBI, financial performance of these firms has declined by -1.6% while net profit
were up by 9.6%.This happened mainly due to sharp cut of 9.3 % in raw material cost. The
import of capital goods and raw material usually increases during industrial growth but this is yet
not visible and it has been negative for November. The fourth indicator of state of industry is the
movement in price. Growths of manufacturing industry prices are still low at 5%.
Conclusion
There is a need for a prudently planned exit from the fiscal stimulus. A phased rollback of the
stimulus is essential to maintain a balance between delivering sustainable growth and stabilizing
the economy. A hastily worked out stimulus could end up being disastrous and counter-
productive for the industry. There also needs to be greater coordination between fiscal and
monetary exits to avoid conflicting results between them. We need to understand that we are not
out of the woods yet and that the darkness might prevail for a longer time than anticipated.

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Topic: Rollback of Stimulus: A Risk or need?

Members Name: Himanshu Mehra

Email Ids: [email protected]

Contact Nos: Himanshu Mehra – 9833880535

Amitabh Vatsya - 9619569674

Course Name: PGDIM

Institute Name: NITIE

Economics defines business cycles as economy-wide fluctuations in production or economic

The size of stimulus has varied significantly

Growth impacts and needs

 The recovery is driven largely by government spending in many economies

Source: Global Financial Stability Report Oct 2009, IMF

The Industrial Growth in India has been

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