Why stimulus has failed to lift the economy

India is going through its slowest threeyear growth period since the Asian Financial crisis. GDP growth is now estimated at 6.1% in 2018-19, 5% in 2019-20, and (according to the IMF) 5.8% in 2020-21. Is India trapped in a new 5-6% growth groove?

Some critics accuse finance minister Nirmala Sitharaman of gross fiscal conservatism and failure to use a big budget stimulus to boost growth. Others have congratulated her for fiscal prudence.

This is a debate in fantasyland, lost in smoke and mirrors. The full extent of government spending beyond its revenue — what economists call the fiscal deficit — is far greater than what the budget admits. The combined deficits of the central and state governments are high enough to have caused financial meltdown in most countries.

India’s problem is not insufficient budget stimulus. Rather, budgets have provided a huge stimulus (cloaked by budgetary fictions) for three years in a row, and yet GDP growth has kept slowing. The failure of such a huge stimulus to stoke growth is deeply worrying. It suggests India’s structural problems are too deep to be stimulated away.

The Financial Responsibility and Budget Management Act of 2003 proposed reducing the central fiscal deficit to 3% by 2008 to check the runaway rise in public debt. The economic boom of 2003-08 produced so much revenue that the target looked achievable. But after the Great Recession of 2008 the economy and revenue growth slowed. Rather than come clean, successive governments fudged budget figures to pretend that they were on the path to cutting the deficit to the 3% target.

The Comptroller and Auditor General (CAG) blew the lid on this. He revealed that budgets were understating the fiscal deficit, which was closer to 5.5% of GDP than the official 3.5%. He showed that instead of borrowing itself, the government was raising loans through governmentowned companies. A second trick was to cloak the true deficit by postponing payments due in one year to the next. So, said the CAG, far from being prudent the government was on a hidden spending spree.

State governments have used the same tricks. Formally, the states have a combined fiscal deficit of 2.5% of GDP, which with the Centre’s 3.5% adds up to a consolidated 6%, second highest in the world. But if we look through the accounting tricks, the full deficit is perhaps 7.5-8% of GDP, making India a world champion in fiscal profligacy.

A big fiscal stimulus can be justified if it finances infrastructure that yields long term returns. However, the CAG has shown that the fiscal deficit is not only huge but mostly wasted in revenue spending. Besides, infrastructure projects take years to plan, get clearances and acquire land. Infrastructure spending cannot be boosted quickly. Land acquisition has stalled two dedicated rail freight corridors planned 15 years ago. Ditto for the proposed Mumbai-Ahmedabad bullet train and giant oil refinery at Ratnagiri.

Exports have stagnated for six years. Without booming exports no country has sustained miracle growth of 7%. Compared with its Asian rivals. India’s costs are too high for land, capital, labour, electricity, freight and other logistics. The World Bank says the turnaround logistical time in India is double Bangladesh’s and triple China’s. India must tackle every high-cost area to become competitive, and this cannot be done overnight. The risk is that India will remain in the 5-6% slow-growth groove for some time.

Many optimists will disagree. They think the slowdown is a blip that will soon go away. One analyst says India has embarked on major reforms like the Goods and Services Tax that in the short run will kill small businesses but will accelerate growth in the long run; that the attack on black money and Real Estate Reform Act will cause much short term pain but eventually clean up and dynamise real estate; that the Insolvency and Bankruptcy Code has been hamstrung by procedural delays but will soon yield major gains. In this view, tough but essential reforms have produced a temporary dip, which will soon be followed by a sharp growth upsurge, in a J-curve.

To me, the continuation of 5-6% growth seems more plausible in the immediate future. But even if the J-curve thesis proves right, that will be a triumph of structural reform, not of a budget stimulus.

India is in deep fiscal trouble. Do not get misled by dubious budget statistics. For many years, budgets have provided a big hidden stimulus, yet that has not revived growth. Let us abandon that failed approach and focus on structural reforms that will pay off with a lag.

What do you think?