The Reserve Bank of India (RBI), Standard and Poor’s, and Fitch Ratings have all added their voices to the growing chorus that the government is responsible for the mess the economy is in. The theme of RBI’s latest credit policy was a curt message to the government: You got the economy into this hole, it’s up to you to get us out of it. So what should the government do?
For starters, take a look at Chart 1 on bank lending to infrastructure. The chart shows that the increase is the lowest in many years. Of course, one reason for the poor showing is because of telecom auctions in 2010-11, which inflated the amount of bank lending to the sector, leading to a high base effect. But other infrastructure sectors, too, have shown a steep deceleration in bank credit. For example, while loans to the power sector grew 42.2% year-on-year in April 2011, by April 2012 it had dropped to 16.8%. Bank lending to the roads sector also shows a deceleration, from 29.2% in April 2011 to 19.7% a year later.
The first thing the government needs to do is ensure infrastructure projects are sanctioned expeditiously. It will then be reflected in increasing lending to infrastructure. To be sure, some of the reasons for stalled infrastructure projects do not admit easy solutions. Coal scarcity, for instance, is a problem for power plants. Availability of land and the compensation that has to be paid are also ticklish issues. Nevertheless, there are some simple ways in which the government can boost investment.
One of them is to tell cash-rich public sector units to increase capital expenditure. The government is already doing this. Another way out can be seen from Chart 2, which shows how the central government’s capital expenditure, as a proportion of total budgetary expenditure, has been declining. That’s because the amount spent on subsidies has been going up. In 2007-08, subsidies were just 10% of total budgetary expenditure. The proportion has gone up sharply, reaching 16.4% in the last fiscal year. And because it has been rising, the proportion of funds left over for capital expenditure has been coming down. The government needs to reverse this. It needs to raise diesel and cooking gas prices and cut back on other subsidies, which will enable it to allot a larger share of its spending to capex.
RBI governor D. Subbarao has made the point that one reason for the persistence of inflation is because the government has not invested in building capacity, but has instead subsidized consumption. A shift of resources from consumption to investment will, therefore, help reduce inflation. For example, the rise in food prices can be mitigated by increasing farm productivity, but for that to happen, it is necessary for the government to shift its emphasis from the fertilizer subsidy to investment in irrigation.
It’s not as if nothing is happening. The Gujarat Co-operative Milk Marketing Federation’s (better known by its Amul brand) managing director said a few days ago he expects a milk surplus this year, which should push down milk prices. Power equipment maker Bharat Heavy Electricals Ltd has reiterated its order inflow guidance of 12-14GW against the poor 2.8GW in FY12. Road project awards are expected to be good this financial year. Project awards for the dedicated freight corridors are also expected in a few months.
Chart 3 shows the year-on-year increase in consumption demand. In the downturn in the early 2000s, consumption growth was much less than in the period after the financial crisis. There are several reasons for this. One is that the Sixth Pay Commission and the debt waiver were consumption-boosting measures taken with an eye to electoral gain by the ruling party. Ditto for measures such as the rural jobs-guarantee scheme. The chart shows the big jump in government consumption expenditure during that time. As the data for 2011-12 show, though, even consumption demand is now tapering off, which should lead to lower inflation in future.
There is a lot the government can do, some of them politically difficult, like reforms, and others easy, like not making life difficult for foreign investors, not carrying out witch-hunts on business and making some announcements to improve sentiment. But even if all it does is switch the pattern of spending from subsidies to capex, that should help deliver growth with lower inflation.
Manas Chakravarty looks at trends and issues in the financial markets. Comment at email@example.com
Graphics by Ahmed Kaza Khan/Mint
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