Opinion | Ignore lines in the sand as policy needs a pivot to aid investment

There is nothing sacrosanct about the fiscal deficit target being 3.5% of GDP. It’s now time to think differently

Usually, fiscal leads and monetary policy follows. But this time around, monetary policy has prepared the stage for fiscal policy when finance minister Nirmala Sitharaman presents her maiden Union Budget on 5 July.

The Reserve Bank of India (RBI) has cut its benchmark repo rates by 75 basis points (bps) over four months. This was accomplished through three consecutive rate cuts in February, April and June. In addition, RBI has changed its policy stance from neutral to accommodative, which rules out any immediate rate hikes.

There are expectations that RBI will reduce rates by another 50 bps during the year because additional rate cuts are considered a necessary and sufficient condition for economic revival. As things stand, monetary policy is being expected to do much of the heavy-lifting to rescue the economy. These hopes have received a fillip from RBI’s dismantling of the existing stringent regulatory architecture. RBI has promised to relax a key component of the prompt corrective action framework—leverage ratio—to boost lending, and to revisit the central bank’s liquidity management framework, which evolved under former governors Raghuram Rajan and Urjit Patel.

However, even in the middle of wildly swinging anticipations, RBI’s monetary policy statement of 6 June hints at the government’s responsibilities for reviving the Indian economy’s animal spirits, which faces fresh risks from weakening private consumption expenditure and investment demand, incipient inflationary pressures because of rising food and oil prices, and global headwinds from trade wars and geopolitical tensions.

RBI’s assessment of the global economy lists three rich economies—the US, the UK and Japan—where economic growth during the January-March quarter has improved because of public spending or government expenditure. The only outlier is the euro area, where economic activity remains weak.

It is, therefore, clear that India also needs public investment or government expenditure to foster growth impulses in the economy. One data point is quite telling. According to the Centre for Monitoring Indian Economy, the monetary value of stalled projects touched 2.68 trillion by the end of March 2019, up more than 600% since June 2018. While this also includes private projects, reviving stalled government projects alone has the potential to jump-start the economy. There will, of course, be the usual lament about rising fiscal deficits and high government borrowings crowding out private borrowing.

However, there seems to be a way out. A Mint analysis of 37 companies (excluding banks and financial companies) from a universe of 67 listed public sector companies (all industries) shows that their reserves and surplus has been going up every year. Between 31 March 2014 and 31 March 2019, the reserves and surplus of these 37 companies grew by 25%. This is based on data available till 7 June. It is evident that many state-owned companies are sitting on idle cash that can be used for expanding infrastructure or enhancing manufacturing capacity. Heedful of foreign portfolio investors and fiscal hawks, the government has been using the public sector undertaking surplus to balance its deficit.

Graphic: Santosh Kumar Sharma
Graphic: Santosh Kumar Sharma


The government’s current expenditure is clearly focused towards pump-priming the economy and boosting aggregate demand. This has been achieved partly through a heavy emphasis on welfare payments and social-sector resource transfers, streaking the government’s economic policy with a social-democratic tint. Only time will tell whether this is a temporary, election-centred strategy, but policy now needs an urgent pivot towards facilitating more investment.

While attempting this, the finance minister must be mindful of two things.

One, investment-based tax incentives could help in attracting investment but must also include labour-based inducements. The current crisis is one of unemployment and stagnating wages. Contrary to popular commentary, implementing labour reforms may not necessarily generate the required investment, just like lower interest rates are never a guarantee for higher investment outlays. Sequencing reforms is critical and labour reforms can only be instituted when unemployment rates are low and the economy can sustain a safety net or social security system for the unemployed. Labour laws in all advanced economies are backed by robust safety nets.

Second, the government should not be afraid of accommodating a slight slippage in the fiscal deficit target. There is nothing sacrosanct about 3.5% of gross domestic product or a line in the sand. The boundaries were drawn in different times when circumstances were different. It’s now time to think differently.

Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal

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