Opinion

It’s time for a fiscal stimulus

Tushar Arora | Updated on January 16, 2018

Work it out: Relax the pressure points

More than supply factors such as debt and slow clearances, poor demand has curbed investment. Public spending is called for

In pursuance of the Budget announcement earlier this year, the Government constituted a five-member committee to review the working of the 12-year-old Fiscal Responsibility and Budget Management (FRBM) Act.

Among other things, the committee was asked to examine the need for and feasibility of pursuing a ‘fiscal deficit range’ as the target in place of the existing practice of a fixed number.

As the committee submits its report by the end of October, it is imperative that the review panel seeks to institutionalise fiscal discipline on the lines of the newfangled inflation targeting framework of the Reserve Bank of India.

However, at the same time, it will be important that the committee takes into account the fiscal rectitude related to economic growth, and give the necessary policy space to the Government to deal with the adverse economic situation related to private investments in the country.

Firing on a single cylinder

At an annualised rate of around 7.5 per cent, India is currently the fastest growing major economy in the world. However, the economy seems to be firing on a single cylinder. While consumption activity (private spending particularly in the urban areas and government spending) is keeping the economy afloat, investments remain dismally absent.

Worryingly, this gap between growth in consumption and investment seems to be widening.

Between FY12 and FY16, while private and government consumption grew at an average pace of 6 per cent, the growth in gross fixed capital formation stood at 4.3 per cent. According to the recently released GDP data for 1Q-FY17, even as total consumption expenditure grew by 8.7 per cent year-on-year, the investment activity declined by 3.1 per cent.

Why the slide

Some of the reasons often cited behind India’s dwindling investment cycle include excess capacity, high leverage of the corporate sector, sub-par demand conditions, delay in clearances, NPAs in the banking sector and high cost of capital. However, as the policymakers seek to fire the additional cylinder of growth (investments), it is crucial to understand the symptoms properly and avoid misdiagnosis of the problem.

Contrary to popular belief, land acquisition and lack of clearances are no longer the key reasons behind the dwindling investment cycle.

According to the database of the Centre for Monitoring Indian Economy (CMIE), 49 per cent of the total projects in FY16 were stalled because of unfavourable market conditions and lack of promoter interest.

Government clearances caused a delay only in 13 per cent of the projects in FY16 compared to 46 per cent in FY13. As we look at the latest report from the CMIE, poor market conditions continue to be a dominant theme for projects getting stalled in FY17.

Therefore, while other factors such as lack of funds, policy clearances and raw material supply remain a source of concern, the most important aspect of the policy response, now, should be to revive the demand conditions in the economy.

Restraints on revival

Although a good monsoon and the Seventh Pay Commission awards could help, there are factors such as deceleration in rural wages or smaller hikes in procurement prices that could restrain a full-fledged revival in domestic demand conditions. It is in this context that fiscal expansion or contraction could be aligned with credit growth, as suggested in the last Budget speech.

Review of the medium-term fiscal consolidation path and commitment to a range of fiscal deficit, instead of a fixed number, could provide the necessary policy space to deal with dynamic business situations.

It is important that fiscal expansion is in line with the borrowing and debt servicing limits of the country.

There are two points to consider in the current scheme of things. One, with the recent decline in bond yields, the rise in servicing cost is likely be much lower this time and affordability could be less of a concern. Two, the difference between cyclical and structural factors behind economic slowdown is critical. For instance, economic activity could be sluggish due to a variety of reasons such as high NPLs, subdued demand conditions and delay in policy approvals.

Taking a step forward

In a situation where demand conditions are robust and perhaps structural reforms are needed for overall repair of the system, mere expansion of government spending may be misleading.

But, in the current context, when slowdown is gradually turning out to be cyclical (because of subdued demand conditions), moderate fiscal expansion could speed up the recovery process. This does not imply that structural reforms take a back seat.

Lastly, there is no doubt that any attempt to discard or review the fiscal deficit target is likely to draw sharp criticism from global credit rating agencies. However, at a time when our BRIC compatriots are considering doing the same, India can at least afford to take a small step in this direction.

More importantly, if the Government ensures that the new resources from the fiscal reset are primarily spent on the creation of long-term assets (capex), a qualitative expansion with higher GDP growth shouldn’t be a problematic message to put across to global investors. Time, then, to loosen the purse strings!

The writer is a senior economist with HDFC Bank. The views are personal

Published on October 21, 2016

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