Chief economic adviser Arvind Subramanian wants increased public investment in the country’s infrastructure to energise the sluggish economy. The problem: this would be risky right now, with threats looming of dollars flooding out of all emerging markets.
The public-private partnership (PPP) model in infrastructure is broken. Many private infrastructure companies have huge, unpayable debts that are being restructured. Subramanian says Indian corporate debt ratios are among the highest in the world. There have been no private bids for many PPP roads or power stations. Hence, clearances of projects of lakhs of crores of rupees have not translated into massive orders for capital goods or construction.
Till a new PPP architecture is created, there’s a strong case for raising the government’s share in investment, but the government lacks cash. Tax revenues have grown at just half the projected rate. So, the fiscal deficit can be kept to the targeted 4.1% of GDP only by slashing public investment, the very opposite of Subramanian’s counter-cyclical proposal.
Can we wait and spend lavishly next year when growth is faster? Maybe. But if slashed Plan spending keeps GDP growth low, the hoped-for acceleration in revenue will not occur, and Plan spending will have to be slashed next year too.
A truly counter-cyclical approach requires bigger fiscal deficits to kickstart growth. Should the government abandon its fiscal targets to step up investment? Arvind Panagariya has suggested letting the fiscal deficit go to 4.5% to dynamise investment. However, this looks too dangerous in the current climate.
When the rouble crashed from 45 to over 70 to the dollar within weeks, Indian markets were roiled too. Financial panic has since eased, but it can rise fast again: contagion is a fact of life. Russia and India may have little in common, but they are both classified as emerging markets by fund managers, and all such countries are affected when one of them sinks.
Falling oil prices have hit not only oil exporters but even oil importers like Turkey and India. The issue isn’t oil but financial interconnectedness. Financial contagion reached its zenith during the 1997-99 Asian financial crisis. It returned, in milder form, in Summer 2013, when the US Fed spoke of raising interest rates. India was hard hit, sinking P Chidambaram’s chances of economic revival.
This can happen again. If oil remains below $65 a barrel for a long period — and this is probable — many companies and countries in the developing world will be severely stressed, and some may default. The consequent financial contagion will hit India too.
How can India insulate itself from this major external threat? Only by looking like the most financially sound emerging market in sight. In Summer 2013, India ran a big current account deficit of 4.9% of GDP and its fisc appeared out of control. It was among the major sufferers in the outflow of dollars at that time.
But subsequently, the current account deficit has fallen, thanks to controls on gold and cheap oil, to maybe 1.6% of GDP. The fiscal deficit target of 4.1% is being adhered to. Inflation is falling sharply, and foreign exchange reserves are comfortable. Hence, India was among the least affected emerging markets when the rouble crashed last week.
But if India goes on a public spending spree, alarm bells will start ringing globally. Financiers will think India has lost fiscal control, and pull out billions of dollars. This can send the rupee crashing and end hopes of faster growth (as happened after the dollar exodus in Summer 2013).
Consider the RBI’s response too. Subramanian’s counter-cyclical approach requires, ideally, that the RBI also lowers interest rates. But the RBI has long cited the fiscal deficit as a source of inflation that must first be controlled before lowering interest rates. If the fiscal deficit goes up, the RBI will respond with tighter money, and may tighten further if financial contagion looks likely. Thus, any attempt to kick-start the economy though massive public spending will be foiled by the responses of the RBI and global financiers.
Create a Cess Pool
A more modest approach will be to take advantage of falling oil prices to raise the cess on petrol and diesel by Rs 2 a litre. The additional revenue will be earmarked for road development and boosting infrastructure without raising the fiscal deficit.
Other options? PSU disinvestments can, in theory, provide additional funds, but investor demand is limited. Recent attempted disinvestments of ONGC and SAIL almost failed, and the LIC had to come to the rescue with its funds. However, sales of government holdings in ITC and other blue chips through the Specified Undertaking of the Unit Trust of India (Suuti) can yield over Rs 50,000 crore.
India’s problem is not just lack of investment. More critically, it is a sharp fall in productivity. After 2012, the investment needed to produce one unit of output has gone up from four to seven units. This must first be fixed by making business easier, slashing red tape and amending laws on land and mines. Raising public investment without raising productivity is not a solution.