The Indian economy
is expected to contract by 10.3 per cent in the current financial year, according to the International Monetary Fund (IMF). The Reserve Bank of India
(RBI) in its first forecast since the outbreak of the pandemic has projected a contraction of 9.5 per cent. Given the level of economic decline, it is reasonable to expect the government to significantly increase spending and support economic activity.
The government, however, has refrained from making large fiscal commitments. The economic package worth over Rs 20 trillion announced earlier this year had limited fiscal outgo — that was rightly focused on providing relief to the most vulnerable sections of the population. The recent announcements related to leave travel allowance for government employees and an increase in capital expenditure by Rs 25,000 crore may not help in a big way. Notably, Finance Minister Nirmala Sitharaman in a recent media interaction said that today’s solution should not cause tomorrow’s problem.
So, is the government’s stance more conservative than warranted at a time when several large countries are intervening heavily to support demand? Probably not. In the current year, according to the IMF’s latest Fiscal Monitor, the general government budget deficit in India is likely to expand to 13.1 per cent of gross domestic product (GDP) compared to the global average of 12.7 per cent of GDP. Thus, India is not an outlier in terms of the relative size of the deficit. The budget deficit in advanced economies is projected to be at 14.4 per cent of GDP, which is not significantly different from that of India. In fact, India’s total public sector borrowing could end up being higher than the IMF estimates. India’s public debt is likely to climb to about 90 per cent of GDP in the current year.
A higher budget deficit is not having the desired impact on the ground, possibly because of two big reasons. First, India was already running a very large deficit. As the IMF data shows, India’s general government deficit was at 8.2 per cent of GDP last year compared to an average of 3.3 per cent in advanced economies. Thus, unlike advanced economies, the existing elevated level of fiscal deficit has resulted in lower incremental spending. Second, India seems to have suffered a bigger revenue loss because of lower economic activity. Remember India imposed one of the strictest lockdowns in the world to contain the pandemic. As a matter of fact, a dramatic decline in the output indicates that the lockdown was effective.
However, India is not the only country which is not able to increase spending because of existing fiscal pressures. According to the data compiled by the IMF, public investment is expected to fall in over 70 emerging markets and developing countries this year because of financing constraints. India is not able to increase spending primarily because of structural fiscal inefficacies.
To be fair, it cannot borrow and spend like the US or other developed countries due to a variety of reasons. For one, the borrowing cost in advanced economies is much lower. In fact, it is close to zero. Also, unlike India, advanced economies are not facing inflation risks. Inflation in India has been running above the RBI’s tolerance band for several months now. Although the new monetary policy committee sees the current bump in inflation as transient, it remains to be seen if the rate actually declines as projected by the RBI. Prices didn’t collapse as many economists were expecting after the nationwide lockdown. Further, India doesn’t have the “exorbitant privilege” of owning a reserve currency.
This is not to suggest that the government cannot create any space for spending. But it will need to be careful as the cost could be higher. Priority must be given to securing an adequate supply of vaccines and providing relief to those at the bottom of the pyramid. The government will need to put large doses of capital in public sector banks to keep the financial system going. It is also worth keeping in mind that India is dealing with external security issues. Even a limited engagement in Ladakh or elsewhere can dramatically change the fiscal reality.
Finally, though it may sound counterintuitive, some increase in infrastructure spending at this stage may not move the needle in terms of reviving growth. It is not easy to quickly scale up infrastructure projects. Also, project implementation is usually a problem in developing economies. Data for over 2,000 projects financed by the World Bank in over 100 developing countries shows that 75 per cent of projects are delayed and 40 per cent cost more than the projected expenditure. India is not particularly efficient in project implementation. As a recent report showed, over 400 infrastructure projects are facing cost overruns and would require additional spending worth over Rs 4 trillion. Besides, it is important to note that a high level of public debt can significantly lower the multiplier effect of debt-financed public spending. Public debt is likely to remain elevated in the medium term.
All this suggests that India has serious policy constraints and is not in a position to aggressively support growth. Thus, a reversal in the containment of the pandemic could significantly worsen the economic outlook.