On Tuesday, May 12, 2020, the Prime Minister of India, Mr. Narendra Modi announced the much-awaited COVID stimulus package of ₹20 lakh crore, which is 10% of the country’s GDP. The question that everyone’s been asking since then – what will be the source of these funds?

We are hazarding some assumptions here: 

  • Reallocation of government spending
  • Tapping domestic private savings
  • Bond purchases
  • Foreign borrowings

The good news is that though the announcements made are worth ₹20 lakh crore, the actual cash outlay by the government and its effect on the fiscal deficit will be far less, at least in the immediate term. That is because, most of the proposals of the government are credit-focused, and others are aimed at easing liquidity concerns for the sectors impacted due to the pandemic. Any costs incurred will initially be covered by financial institutions and will not result in actual cash outflow by the Centre.

Reallocation of government subsidies

Most of the existing government spending goes towards the subsidies, for food, fertiliser and fuel. ₹70,000 crore of these subsidies can be released for increased fiscal spending.

Privatisation of PSUs

Government decided to use equity to raise private funds via large-scale privatisation of PSUs. Not only will this help in raising required funds but will also improve the efficiency ofpublic firms when run jointly by private investors.

The number of PSUs in strategic sectors will be maximum four, remaining will either be privatised or merged. As per the new public sector enterprise policy, all sectors will be open to private sectors and PSUs will play a significant role in defined areas.

Bond markets

In the near-term, the funding burden will fall on bond markets and for it to stabilise markets, RBI’s participation is of prime importance. Market borrowing is likely to rise by at least ₹7-10 lakh crore via domestic means and bond issuances. RBI will play a key role in stepping up bond purchases since absorptive capacity of domestic investors and foreign portfolio investors is limited.

Tax-free bonds

These may turn out to be a preferred investment option for retail investors who are seeking debt mutual fund schemes. These bonds will open a new avenue of participating in a government instrument free of tax.

Foreign borrowings

  • FCNR account deposits

In 2013, at the time of taper tantrum, RBI permitted foreign currency non-residents (FCNR) account deposits, which fetched an inflow of $30 billion in FCNR bank deposits and attracted huge funds from abroad. This strategy may be reimplemented. Moreover, given the fact international borrowing costs are likely to be low, we can be open to foreign currency debt.

  • FDI

Being open to equity investment by foreigners is a smart way to fund our current and urgent needs.

With this in mind; in the fourth tranche of government’s ₹20 lakh crore special economic stimulus package, Finance Minister Nirmala Sitharaman raised the Foreign Direct Investment (FDI) in defence manufacturing to 74% from 49% via automatic route and announced several measures to make defence production self-reliant in the country under Make in India.

Increase in Direct Taxes

Depending on increased taxes is not a great idea as it will only deplete private spending and lead to huge inefficiencies in implementation. Besides that, there is a need of not just the government expenditure but also private consumption and investment for the economy to recover.