Indian shoppers at market in Ahmedabad ahead of Diwali festival in 2018. Photo: AFP

MUMBAI – Faced with its biggest yearly economic contraction since Independence, India on Monday unveiled a stimulus package to revive demand to coincide with the main Hindu festival of Diwali, generate more revenue for the government and get states to focus more on capital investment.

Ironically, the plan was unveiled hours before the Ministry of Statistics said industrial growth in August slowed by 8% and the consumer inflation rate rose by 7.34% in September, an eight-month high, compared with 6.69% in August. The central bank’s target is to keep the rate between 2% and 6%. Rising prices usually lead to consumers spending less.

The demand stimulus plan by Finance Minister Nirmala Sitharaman’s team aims to entice 3.5 million central government employees to spend more from their own perquisites that they haven’t been able to utilize because of the pandemic and the subsequent lockdown.

Sitharaman estimates that her three-part plan would incentivize employees to spend more and help revive demand and kick-start a virtuous cycle of demand, sales and investment over time. The total demand boost because of today’s measures is expected to be more than one trillion rupees ($13.64 billion), Sitharaman said on Monday.

The package includes making an interest-free advance payment of Rs10,000 to all employees as part of their wages for festival purchases in the form of a pre-paid card, valid until March 31. Another part covers the leave travel allowance, which is an income tax-exempt part of staff salaries. Government employees can opt to take cash in lieu of the leave they would have taken for travel. Employees will also receive three times the ticket fare.

The condition is that the employees must spend the full amount received on goods and services that may attract at least a 12% Goods and Services Tax (GST). The reasoning behind it is that both employees and the government gain from the travel leave encashment, which otherwise would have lapsed for most employees.

“The Covid-19 pandemic has adversely affected the Indian economy,” said Sitharaman. “The supply constraints have eased but consumer demand is still affected.”

A large section of those working for private-sector companies or small-scale units faced the brunt of the pandemic. A large section faced cuts in perks and salary. Many lost jobs and saw savings depleted during the initial months of the pandemic and lockdown. Government employees, in contrast, escaped most of these adverse effects. With their jobs and salaries protected, they in fact saw an increase in their savings.

Not all are convinced that the demand stimulus would work as desired.

“The increase in consumer expenditure will depend upon how many employees avail of the scheme,” said Madan Sabnavis, chief economist at CARE Ratings in Mumbai. “The changed spending preferences because of the pandemic too could limit the overall spending. If the tendency was to increase savings during the pandemic the thrift motive may continue to dominate.’’

To promote capital expenditure by states the central government is giving 50-year loans of 120-billion rupees for investments on infrastructure and asset creation. It is hoped that this will to help trigger a multiplier effect on the economy.

The finance minister also allocated an additional 250 billion rupees to the central government for spending on public works programs such as roads, defense, water supply, urban development, and the promotion of local industries.  

The proposed measures are designed to stimulate demand in a fiscally prudent way by advancing or front-loading expenditure, the finance minister said.  

“If demand goes up based on the stimulus measures, it will have an impact on those people who have been affected by Covid-19 and are desperately looking for demand to keep their business going,’’ Sitharaman said.