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Business News/ Opinion / The case for a fiscal push in India
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The case for a fiscal push in India

In the absence of structural reforms, a limited stimulus may help India

Illustration: Jayachandran/MintPremium
Illustration: Jayachandran/Mint

The Narendra Modi government seems to be preparing to support the fragile economic recovery with a spending push.

The strong growth in indirect tax collections in the first three months of the current fiscal year has provided the government with extra financial resources that can be used to increase public spending without breaching the annual fiscal deficit target. Finance minister Arun Jaitley hinted at such a stimulus in Parliament on Wednesday.

There are three reasons why the idea is worth pursuing.

First, the other levers for stimulus cannot be used right away. There is little scope for significant monetary easing right now unless there is a further collapse in global commodity prices. The 0.75 percentage point of cumulative rate cuts we have seen since January have anyway not yet been adequately transmitted into the economy. The relative stability of the rupee compared with other emerging market currencies means that a boost to effective demand through higher exports is not likely right now. The fiscal situation is far more supportive of stimulus.

Second, there are indeed growing signs that economic momentum is picking up. Most economists agree the ongoing recovery will eventually weaken unless private-sector investment picks up. However, there are two obstacles. Most surveys of the private sector show capacity utilization is still low. In other words, firms can meet additional demand by using their excess capacity rather than having to build new capacity.

Also, corporate balance sheets are weighed down with excess leverage. Many corporate groups would rather use cash flows to retire debt rather than for capital expenditure. The Economic Survey published by the finance ministry this year had made a strong case for higher public investment till such time as private-sector investment recovers.

Third, there is a cyclical recovery on. Earlier in the week, Reserve Bank of India governor Raghuram Rajan said economic momentum is picking up. The central bank had said in its June policy statement that it saw a poor monsoon as one of the biggest threats to its growth forecast. The rains have been better than expected till the end of July.

There are other positive indicators as well. The recent data on car sales suggests urban consumer demand is picking up. The fall in global oil prices creates positive real income effects in an importing country such as India. The growth in bank credit is not as bad as some believe it to be once you adjust for lower borrowing from the oil companies, greater corporate dependence on commercial paper and the overall decline in inflation.

Now, two notes of caution.

First, the output gap could quickly close in the coming quarters in case the recovery strengthens. Any further boost to growth could then become inflationary. The finance ministry has to be careful that its spending push is focused on infrastructure investments, which will raise potential growth in the coming years, rather than spend on programmes that will spur inflation in the medium term.

Second, it is important to remember a basic rule in policy strategy: cyclical instruments cannot deal with structural problems.

Specifically, the use of an anti-cyclical policy tool such as higher public investment definitely makes sense when it comes to addressing a cyclical issue such as weak private-sector investment. But it must also be pointed out that the use of such an anti-cyclical policy tool is no substitute for the sort of structural reforms that are needed to address the underlying structural problems in the Indian economy.

Jaitley has said in Parliament this week that India can grow in excess of 8% a year “if banks are recapitalized, GST (goods and services tax) implemented, stalled projects revived and infrastructure spending improves". The finance minister has in effect sent out a subtle warning that higher government spending is not the entire answer. A lot of underlying structural issues still need to be sorted out.

The bottom line is that higher fiscal spending is welcome at this juncture as long as the deficit target is not breached. But, it is not a magic wand.

Can public investment substitute weak private investment? Tell us at views@livemint.com

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Published: 06 Aug 2015, 08:35 PM IST
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