Fiscal Stimulus equivalent to 4.8% of GDP desirable
Rs. 3.0 Lakh Cr of government guarantees for Covid loans to MSMES and corporates can address banks’ risk aversion

Covid-19 lockdown has led to severe economic disruption in India since the second half of March 2020. As we head towards, which hopefully are the last few days of the national lockdown phase, the time is clearly right to work out a reconstruction plan for the economy. Acuité Ratings had earlier estimated that the economic losses in every day of the lockdown amounts to over USD 4.5 billion and the current lockdown till early May 2020 will lead to cumulative losses of over USD 150 billion. The actual losses are expected to be higher and set to continue well into Q2FY21 since the economic activities will revive in only a gradual manner with a risk of continuing lockdown in the Covid-19 hotspots over the next 2-3 months.

Given that the virus lockdown came closely following a weak growth trajectory, Acuité believes that a contraction in GDP in Q1FY21 aside, there is a significant downside risk to our growth estimates of 2%-3% for FY21 unless there is an appropriate and timely stimulus package for the economy. Ideally, we would like the government to opt for a stimulus package of Rs. 11.2 Lakh Cr (USD 150 billion), the economic loss that is already set to be recorded for the current lockdown period and that will tantamount to 4.8% of FY20 GDP. However, in our opinion, it is not so much the size of the package but its effectiveness that will be the key to a healthy revival of the economy by H2 FY21. The stimulus should primarily focus on maintaining productive government expenditure including capital expenditure to the extent possible, given the latter’s ability to push up growth. In this note, we have deliberated on the quantum and possible mechanisms for delivery of the stimulus from the government in the context of limited fiscal resources.

The central government had already announced a Rs. 1.7 Lakh Cr stimulus package under Pradhan Mantri Gareeb Kalyan Yojana (PMGKY) to address the needs of the vulnerable segments of the population who are severely impacted by the ongoing lockdown and economic disruption triggered by Covid-19. This was primarily to ensure food security and sustenance for farmers, rural daily wage workers, construction workers, senior citizens and women in the low income groups. Some moderate support had also been announced for SMEs through temporary payment of their PF dues and extension of timelines for payment of GST. However, such measures will not be adequate to sustain the vulnerable businesses for a protracted period of disruption which in turn, magnifies the risks of insolvency and job losses in the economy. While the need for a larger government stimulus is acknowledged by almost all stakeholders, it will also be important to ensure that it is fiscally efficient and well targeted given the constraint of resources.

While the market awaits the next tranche of stimulus from the government, RBI continues to play a key role in the current crisis by ensuring adequate liquidity in the monetary system. Apart from a generous infusion of Rs. 4.2 Lakh Cr of liquidity in the banks since March 2020, it has also effected an additional cut in the CRR and the reverse repo rate, over and above the 75 bps repo rate reduction to encourage lending by banks. Additionally, RBI has deployed the LTRO and the refinancing programmes through financial institutions (SIDBI, NABARD & NHB), which is expected to provide liquidity to the corporate and the NBFC sector. The percolation of such liquidity to the latter, however is significantly constrained by the increased risk aversion in the banking system. Banks particularly in the public sector category burdened with very high NPAs over the last 5 years, are clearly hesitant to take additional exposures in those leveraged sectors where cash flows are likely to be under severe pressure in the current fiscal. In the opinion of Acuité, any stimulus from the government or RBI has to address this fundamental challenge of credit aversion in the banking system.

Needless to say, a large stimulus package from the government funded through market borrowings will have a highly adverse impact on the fiscal position and will reverse the gradual improvement that India has witnessed in fiscal management over the years. In a scenario, even where say the stimulus amount is curtailed to 8.0 Lakh Cr and is raised through additional borrowings, it will lead to a spurt in the gross and net borrowings of the central government to Rs. 15.9 Lakh Cr and Rs. 13.5 Lakh Cr respectively in FY21. This will not only more than double the borrowing levels as compared to the previous year but will take the fiscal deficit beyond the permissible limits of stakeholders such as the rating agencies, to reach almost 7.0% of GDP as compared to the budgetary estimate of 3.5% and also possibly trigger a longer term fiscal challenge. This will further lead to a sudden spike in government borrowing rates from the current levels of 6.2%-6.4% and substantially offset the lower interest rate regime that has been brought about by an accommodative monetary policy of RBI. While a higher supply of government papers may see an increased interest from a section of FPIs, any associated deterioration of macroeconomic indicators such as inflation rate along with a risk of a downgrade in the sovereign rating, may reverse the investor appetite levels and will further crowd out private sector borrowings.

In this backdrop, Acuite Ratings has some suggestions on both the stimulus mechanism and mobilisation of additional funds required to support a timely stimulus programme from the government.

Provide guarantees or loss reimbursement facility to banks

Some of the sectors in the economy have been more severely impacted than others due to the lockdown and the social distancing requirements and importantly, such impact likely to continue for a longer period extending to a few quarters. Many of these relatively vulnerable sectors may need additional working capital support to tide over the current crisis, pay employee salaries and also restart their operations. Lack of timely funding support from banks or others sources may lead to permanent impairment of businesses and loss of employment, thereby leading to a longer term damage to the economy. The headwinds are surely greater for the MSME segment where balance sheets are not large enough to absorb the sudden shock from the Covid lockdown. The banks therefore, should be encouraged to provide additional working capital facilities upto a certain proportion of their existing limits with a backstop guarantee from the government, any of the government institutions or a SPV/fund set up for the purpose by the government with an upfront capital contribution. There can be different funds or SPVs for different sectors or segments like MSMEs, NBFCs and MFIs. These funds will not only provide guarantees for bank loans but also infuse equity or subordinate debt, if necessary. The upfront fund infusion from the government will only be fraction of the guarantee amount and significantly less than in the scenario where it needs to give direct upfront funding support to the liquidity starved sectors including MSMEs. Some provisions for these guarantees, nevertheless, will have to be made in the budget over the medium term.

Acuité Ratings estimates that an amount of Rs. 1.8 Lakh Cr additional working capital funds will be required by MSMEs and another Rs. 1.2 Lakh Cr by corporates in relatively more vulnerable sectors which aggregate to Rs. 3.0 lakh Cr. These funding can be provided to eligible companies by banks or NBFCs with a guarantee from the government sponsored fund or SPV.

Deploy deficit financing from RBI

Given the extraordinary nature of the global economic and health crisis sparked by Covid-19, we believe there is adequate justification to raise debt or finance the deficit directly from RBI at this juncture albeit within specified limits. In order to ensure that the interest obligations on such additional off-market borrowings is not unsustainable, the feasibility of a special one-time issuance of special zero coupon securities by both the central and the state governments to RBI can be explored. If the entire proposed stimulus amount of Rs. 11.2 Lakh Cr is raised through this route, there will be a sharp growth in the balance sheet of RBI to the extent of 47% as compared to the average growth of 22%-24%. While there has been a steady growth in net foreign assets (NFA) through dollar purchases over the years driven by high FII flows and RBI’s intent not to permit undue appreciation of the rupee, it will not be feasible to offload such dollar reserves in the market and replace them with domestic assets (i.e. government bonds) at these times, given the likely impact on rupee volatility. Therefore, the downside risk to the deficit financing model is an unavoidable expansion of the RBI balance sheet, 60% of which (based on empirical estimates) will have to go to the currency in circulation (M1), sharply increasing it by over Rs. 6 Lakh Cr. Needless to mention that such a quick growth in money supply can be inflationary but we believe that if the supply of goods and services picks up rapidly, it can be brought under control within a few months.

State Governments to share partial burden of stimulus

Given the debt burden of a large stimulus package, it may also be a good idea to ask the states to share 50% of the additional borrowings of Rs. 11.2 Lakh Cr if they are to be raised from the market. Under this scenario, the central government’s gross borrowings will rise to Rs. 13.5 Lakh Cr which is equivalent to around 6.0% of GDP, a relatively more acceptable figure in an exceptional year.

It may not be feasible for all states to share the debt burden of the stimulus given their respective fiscal position. Therefore, a few relatively stronger states with lower fiscal deficit levels may volunteer to take up around Rs. 3 Lakh Cr of additional borrowings. We suggest a group of six states i.e. Karnataka, Gujarat, Tamil Nadu, Maharashtra, Haryana and Telangana where the current fiscal position is relatively better vis-à-vis other states with an average state fiscal deficit of 2.4%. Even with the additional debt from the pool, their average fiscal deficit is expected to remain below the threshold of 5.0%. The rest of the debt requirement can be raised amongst the remaining states based on their economic fundamentals and fiscal position.

The fiscal implications for such a debt sharing arrangement is provided in Table 1. It goes without saying that such a debt sharing mechanism among the central and the state governments can only work when there is consensus and close coordination among them. States can deploy the funds raised on their balance sheets for providing a stimulus package to business clusters at the state level while also supporting farmers and labourers.

Conclusion: No debt bigger than continuity

There is no doubt that any additional debt raised for stimulus will have an adverse impact on the fiscal trajectory in a period marked by severe economic disruption and sharply lower tax collections in the short term. However, Acuité continues to believe that the repair and revival of the economy through public expenditure is a priority in today’s scenario where the slowdown in demand has been further hit by Covid-19.

With continuing lower global oil prices and the resumption of economic activities in India, the fuel tax collections are expected to rise (with no expected retail price pass through) and may help to partly offset the impact of the incremental debt issuances. From the perspective of debt sustainability, we estimate that if the domestic economy manages to grow at 7.0%-7.5% in real terms for the next five years (post FY21), the incremental tax revenues shall be adequate to support the additional debt raised during this Covid period.



Table 1: Distribution of Debt

Six Major States#

All States

India (Centre)

 Revenue Loss (Rs. Cr)




 Fiscal Deficit (Rs. Cr)




 Additional FD (Rs. Cr)




 Total FD (Rs. Cr)








 Additional FD/GDP




 Total FD




Source: Acuité Research

#States Considered: Maharashtra, Gujarat, Tamil Nadu, Haryana, Telangana and Karnataka