To grow or not to grow

The Pak Banker - - OPINION - T. T. Ram Mo­han

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.

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