Mint Explainer: How FM's capex focus is meant to work

Why is the government giving a big push to capital expenditure?

The Indian economy is gradually recovering from the devastation of the pandemic. In fact, it’s now already the fastest-growing major economy in the world, expanding at more than 8.7% last fiscal and is projected to grow at around 7% this fiscal. The government wants to nurse this incipient economic recovery amid global macro-economic headwinds. It plans to do this through an ambitious capital expenditure programme this fiscal.

Capital expenditure refers to investments in upgrading existing or building new physical assets by the government or private businesses. Now, as businesses expand, capex has a multiplier effect on the economy, creating demand and unleashing animal spirits.

It was a strategy the government adopted — a trend seen in other countries as well — to shield the economy as much as possible from the impact of the pandemic.

What does the government hope to achieve through capex?

Sitharaman and her team are hoping that a thrust on capex will ease supply-chain bottlenecks and revive demand. So, while capex can add to the productive capacities of the economy, boosting long-term growth, it will also spur job creation and consumption.

In the last Budget, Sitharaman announced a big jump in the government’s planned capex for this fiscal. In 2022-23, the government will have a capex spend of ₹7.5 lakh crore (even more if you add grants-in-aid for capital assets including MGNREGA) — a spike of 27% over the estimates for the previous year (2021-22). Crucially, Sitharaman hopes it would crowd-in private capex into the economy. The government has ambitious plans to exponentially ramp up spending on expressways, logistics parks, metro systems and housing — much of this work will be sourced out to private contractors.

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Can the government crowd out the private sector?

How times change! For long, the government has been wary of excessive borrowing and spending, even on capex, worried about crowding out the private sector. But clearly there is a change in mindset at North Block now. Indeed, Sitharaman’s team has tried to dispel concerns of the government eating into the private sector’s share of national savings. Last year, Sebi whole-time member G Mahalingam said, “No doubt, a good part of the bond market gets crowded out by government issuances." Mahalingam couldn’t have been more emphatic. “That (government borrowing) crowds out all the corporate bond market, no doubt about it… which means manufacturing companies continue to depend on banks as a source of capital," he said.

The government openly disagreed with Mahalingam. Krishnamurthy Subramanian, then Chief Economic Advisor, said it was a specious argument that “relies on the pool of savings being static". There was mounting evidence that savings were “pro-cyclical with growth", said Subramanian, asserting that if the government spends more, it pushes growth and increases savings, leading to a crowding-in of private investment.

Can government spending revive private capex?

Private investment has been comatose since the global financial crisis in 2008 largely due to the twin balance-sheet problem in banking and corporate sector. To revive private investment, particularly in manufacturing, the government has taken a raft of measures in recent years — from the introduction of the GST and the Insolvency and Bankruptcy Code (IBC) to the thrust on infrastructure creation. Sitharaman also unveiled audacious corporate tax cuts in 2019, slashing the base rate to 22% from 30% and for new manufacturing companies from 25% to 15%. Corporate tax rates in India now are among the lowest in the world. But the move has not yielded the results it should have, perhaps in some measure due to the Covid-induced economic meltdown.

What is the global experience?

Globally, aggressive fiscal and monetary policies kept economies afloat during the pandemic. Simply, the governments went on a spending spree while central banks cut benchmark rates to stimulate demand. Some economists believe this may have triggered a possible overheating of the global economy, leading to an inflationary surge. There is now a rethink in the developed world on big government spending. In the US, for instance, President Biden is now talking about reining in government stimulus for the economy to tamp down inflation. Sitharaman is trying to keep deficits in check by trimming government subsidies, including those on MNREGA, which is a politically contentious move.

Can the government’s capex drive fuel inflation?

The Reserve Bank of India has already begun raising repo rates to rein in demand-pull inflation. But the inflationary spike in India is in part a consequence of global supply-side bottlenecks triggering a rise in commodity prices. A normal monsoon will help in easing the elevated food prices. Sitharaman has allayed concerns over inflation, arguing that India is better placed than other countries.