Can FM Kick-start Growth in Today’s Scenario of Appreciating Dollar?

The ‘Mid-Year Economic Analysis 2014-15’ tabled in the Parliament by the Finance Ministry reveals that the aggregate revenue has been growing at about 10 percentage points below the budgeted projections. It otherwise means that there is a likelihood of shortage of over Rs. 1 lakh crore in the revenue from the projections made in the budget. It means containing the fiscal deficit at the targeted level of 4.1% for FY 2015 is beyond the reach of the Finance Ministry.

But the review said: “The Government is committed to meeting the fiscal target for FY 2015….” It therefore compels one to fear that expenditure cuts are in the offing, for reasons galore: One, however aggressive the government might be to disinvest its stake in the PSUs, it may not succeed in today’s not-so-encouraging global financial environment. Indeed that’s what had happened when it earlier tried to disinvest ONGC and SAIL: but for LIC chipping in, it would have simply failed.  Two, the economic growth for the current financial year has been pegged by the report at around 5.5% of GDP, which is no better than what has been achieved in the first half of the year. Three, although there appear some signs of private consumption stirring up, the report indicates that private investment is still to pick up.

Over it, the challenges for economic growth, according to the economic adviser, are essentially from within the country, the most important among them being the experience of the last few years of over-exuberant investment, especially in infrastructure and in the form of public-private partnerships that today stand broken. The reasons for their failure are pretty obvious: delays in land acquisition and environmental clearances, variability of input supplies, etc.  Thus, there are today “stalled projects to the tune of Rs 18 lakh crore, about 13% of GDP.” Over it, the over-indebtedness of the Indian corporate sector with median debt-equity ratios at 70% is incidentally said to be the highest in the world. This fact has indeed created ripples in the banking sector, for the restructured debts constitute around 11-12% of their total assets. Bitten by this risk, banks, the report says, are obviously not so enthusiastic in funding fresh projects from the real sector. The analysis also felt that projects such as roads, public irrigation and basic connectivity might no longer entice the private sector to embrace, for the lessons from the PPP experience from the past indicate that given India's weak institutions, there are serious costs that the private sector which is taking up project implementation risks has to bear. That being the growth prospects, it is anybody’s guess how ambitious it is for the Finance Ministry to contain the fiscal deficit within the targeted 4.1%, unless, it goes for drastic cut in the planned expenditure in the remaining months of the fiscal 2015.  

Against this reality, Dr. Subramanian, the Chief Economic Adviser said: “I think we will have to re-evaluate the fiscal strategies generally.” He indeed went a step further when he advised the government to consider a case not just for a counter-cyclical but a counter-structural fiscal policy, motivated by reviving medium-term investment and growth. He also said “that public investment itself could be an engine of growth going forward.” 

Now the question is: Is all this not a bundle of contradictions? If Dr. Subramanian’s counter-cyclical approach is adopted to kick-start growth, obviously, government has to give a go by to the fiscal prudence. Implicitly, Dr. Subramanian is also suggesting RBI to cut down interest rates. Of course, there is another economist, Dr. Arvind Panagariya, who too suggested for expansionary fiscal policy to ignite growth—let the fiscal deficit be around 4.5% of GDP.  Industry too is clamoring for policy interest rate cuts by RBI to stimulate growth.

That said, we need to examine if India can take the risk of public spending to stimulate economic growth at the cost of rising fiscal deficit in today’s global financial climate. Oil prices are falling, and dollar is strengthening.  Rubble had crashed from 45 to over 70 /dollar within weeks. It of course didn’t affect India yet because, inflation is falling down and our foreign exchange reserves are comfortable. But this may not hold good for long, particularly, if the government resorts to public spending on infrastructure.

Such a move would spread wrong signals among the global investors. Fearing India has lost fiscal control they may flee—pull out billions of dollars. And as the oil and other commodities prices fall and dollar strengthen against all currencies, deflation is likely to spread worldwide. Cumulatively, these global developments are certain to put rupee on a sliding spree. Once that happens, RBI is sure to step in and initiate measures that would run counter to what Dr. Subramanian recommended. Over it the falling oil prices are sure to hit Indian corporates, for the markets have become highly vulnerable to contagion risk. It means Indian companies will face further stress in demand for their goods leading to their defaults even.

It’s a pretty awkward situation—if fiscal deficit commitments are to be met, expenditure must be curtailed; if growth is to be stimulated public expenditure must sharply be increased. Finding a sensible balance is the real challenge to the Finance Minister and his economic adviser, which they have to address with deftness while presenting the 2015-16 budget.