To grow or not to grow
THE coming Union Budget is a huge challenge for the government. The world economy is facing the severest stresses since the financial crisis of 2008. In 2015-16, the Indian economy will grow at 7-7.5 per cent, less than the 8.1-8.5 per cent projected earlier. On present trends, growth in 2016-17 will not be any higher than in 2015-16. India's public sector banks (PSBs) are in their worst shapein over a decade. The stock market has declined to the level seen before the Narendra Modi government assumed power in 2014. Against this background, the promise of an early return to the growth path of 8 per cent has faded. The Budget must do what it takes to ensure an early return. As the animal spirits of businessmen are weak, government spending must take the lead.
Following the financial crisis of 2008, the government knew what to do. It opted to provide both fiscal and monetary stimuli - as govern- ments the world over did. This was the obvious thing to do then because there was space for both types of stimuli. Growth revived strongly in India after the crisis (although we had to reckon with higher inflation down the road).
The situation today is different. The space for fiscal stimulus is limited by the commitment on a fiscal consolidation path given by the government. The space for monetary stimuli is limited by the monetary policy framework agreed to by the government and the Reserve Bank of India, which commits the RBI to a time table for meeting specified targets for inflation.
As a result, the government today faces critical choices. Should it opt to accelerate growth in the present situation? If so, should it do so through fiscal stimulus or by creating conditions for a monetary stimulus? And how should it go about restoring the health of PSBs so that credit growth is not undermined?
The answers must be determined by the conditions on the ground. India's growth is estimated to be below its growth potential. Two sources of aggregate demand, exports and private investment, are weak at the moment. Greater public investment is clearly the answer.
In the coming year, the government is not in a position to reduce costs significantly enough (by pruning subsidies drastically, for instance) or to raise revenues sufficiently (by disinvestment or a buoyancy in tax revenues). Something must give. This has to be the fiscal deficit target of 3.5 per cent for 2016-17. Many economists oppose any departure from the stipulated path of fiscal consolidation. They say it will undermine investor confidence in the Indian economy. They warn that FIIs will flee the Indian market, and this will devastate the markets and the rupee.
One doubts that the situation is as grim as that. Foreign investors will see the case for boosting growth in the present international environment. They know that India's macroeconomic indicators are in better shape than those of most emerging markets. Rational investors will focus on the quality of spending, not the size of the fiscal deficit itself. As long as the departure from the fiscal deficit target is on account of higher investment spending (which is growthinducing), they are unlikely to take a harsh view of matters.
In his recent C.D. Deshmukh memorial lecture, RBI Governor Raghuram Rajan makes a stronger argument against any relaxation in fiscal consolidation. He believes attempts to boost growth can end up delivering even slower growth in future. He cites the example of Brazil that went down the path of fiscal stimulus only to end up with a shrinking economy last year. India's consolidated fiscal deficit of the Centre and the States, he points out, is rivalled only by that of Brazil.