Focus on small spends to revive economy

The world is staring at an unprecedented economic reversal. Recession of a significant order knocks on the doors of 190 nations. What is the role of economic policy in these times? The first steps have come from monetary policy. Action (in India as well as across the globe) has been swift and front-loaded. This is what the Reserve Bank of India did — drop rather dramatically the policy repo rate with the expectation that interest rate reduction will revive economic growth. But it hasn’t worked out that way.

The latest data released on May 29, 2020, by the government shows the growth rate recorded in 2019-20 was lower at 4.2 per cent than the 6.1 per cent recorded in the previous year and 8 per cent in 2015-16. The quarterly data for 2019-20 shows that the growth rate has decelerated continuously in all the quarters, beginning at 5.1 per cent in Q1 and finishing at 3.1 per cent in Q4. In short, the pandemic has come to hit us hard at a time when we were already down and reeling. This double whammy couldn’t have come at a worse time.

Growth numbers

A perusal of more disaggregated data shows that the lower growth is primarily contributed by negative growth in gross fixed capital formation (GFCF), which broadly is the investment in the economy. The GFCF recorded negative growth rate of 3.1 per cent, 5.16 per cent and 6.48 per cent respectively, in Q2, Q3 and Q4 of 2019-20. Now consider that cumulatively from February 2019 to May 22, 2020, the policy rate has been reduced by 225 basis points. However, the weak transmission mechanism of monetary policy has not effectively translated the policy rate reduction to a consequent bank lending rate reduction, which recorded a drop of 114 basis points, accounting for only about 50 per cent of the policy rate reduction. Thus, the negative growth of investment, when seen in conjunction with the policy repo rate reduction and its transmission to bank lending rates, conveys that a front-loaded monetary policy action is futile. This must, first and foremost, be recognised.

Let us turn to fiscal policy. The growth disaggregated data tell us further that the government final consumption expenditure (GFCE) has supported the growth momentum, recording a positive and higher rise in the range of 6.23 per cent in Q1 and 14.18 per cent in Q2. The increase in consumption expenditure by the government is also corroborated by the latest data released by Controller-General of Accounts (CGA), which shows that in 2019-20, despite shortfalls in the revenue receipts, the revenue expenditure was maintained at the revised estimates level.

However, there were cutbacks in capital expenditure, which are reflected in the negative growth in investment in the real GDP data, as mentioned earlier. The fiscal deficit in 2019-20 was recorded at 4.6 per cent of the GDP as against 3.8 per cent in the revised estimates and 3.4 per cent in 2018-19. The fiscal slippage was more pronounced in tax revenue (₹13,55,886 crore as against ₹15,04,587 crore in the revised estimates) and disinvestment proceeds (₹50,304 crore as against ₹65,000 crore in the revised estimates).

It is important to note that the Covid-19 impact on the Indian economy in fiscal 2019-20 was only in March, to some extent, but as the analysis has unfolded, growth has been weak otherwise and policy interventions did not work. The 2020-21 fiscal will be worse in terms of growth and employment. But unfortunately, we do not have any estimated number from the authorities except the RBI Governor’s statement, where he has mentioned that there will be a recession. Consensus estimates project negative growth in the range of 4-5 per cent. Fiscal deficit in 2020-21 could shoot up in the range of 5-6 per cent of GDP, only for the Central government. Adding the State government’s fiscal deficit conservatively at 3- 3.5 per cent of GDP, the general government deficit could be 8-9 per cent. This is alarming by any standards.

Spending needed

What, then, is the solution? Globally, there has been a call for the governments to “spend” their way out of the crisis. In Europe, the ‘Stability and Growth Pact’, which is the region’s own FRBM-equivalent that packs in a set of rules designed to ensure that countries in the European Union pursue sound public finances and coordinate their fiscal policies, has been discontinued. What is in the forefront is heterodox economics, advocating printing unlimited money and financing government expenditure on the argument that inflation is not a problem with lower oil prices and a good harvest.

But one needs to be careful with printing money to stabilise the unstable economy, as there is an inherent Ponzi game written into any exercise that seeks to bring about a revival based on nothing more than stimulus — the larger this effort, the larger the risk of being caught by the so-called Minsky moment, later if not now, without any real gains from the exercise.

What we need is spending, but such spending must be calibrated and driven towards longer-term stabilisation in critical areas like health. As the World Bank chief economist Carmen Reinhart has observed, “If it (Covid-19) is not over on the disease, it is not over on the balance sheet.” In India, the short-run solution could be fiscal intervention, as monetary policy has done its bit to revive and restore growth. But fiscal accounting is important, particularly at the level of the end-spenders, ie the State and local governments. Therefore, at the intuitional level, strengthening the local government and local administration for effective and efficient use of health expenditure is critical.

Unfortunately, this is precisely what the government has neither spoken of, nor is it focussed on. Typically, boosting infrastructure leads to talk of bullet trains, super highways and mega roads and bridges. These are what the dams used be in the yesteryear. What we need is a series of smaller spends — distributed out across the nation and focussed on delivering good, decent, cost effective health solutions so that we can truly reap the demographic dividend.

Today, it looks like the vast population of India is a demographic burden — given the way the nation has treated its workers. Changing this will require much more than a stimulus package;₹20 lakh crores cannot fix these wrongs, but the right approach and clarity of purpose will drive the stimulus toward making lasting change.

Through The Billion Press. Pattnaik is a former Central banker and a faculty member at SPJIMR. Views are personal

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