Budget 2019-20: Private investment in India has floundered not because funding costs are too high or banks are hamstrung with bad loans or the exchange rate is too appreciated, as is collectively bemoaned.
By Jahangir Aziz
Budget 2019 India: Since the February interim budget, the global economy has changed dramatically. We now know that the US-China trade tensions have not only had a much larger direct effect on both countries and those connected to the China supply chain but also its indirect impact, via dampening business sentiment, has been so large that global capital spending is now tracking its lowest in several years. Notwithstanding the assurance made by both China and the US in the recent G-20 meeting to return to negotiations, the languishing of global investment has forced many analysts and major central banks to lower growth forecasts and prepare for a potentially sharp economic slowdown. From the Fed to the ECB, almost all central banks, including those in India and other emerging market economies, even those with large current account deficits, are planning to provide substantial policy support to keep growth afloat. In India, the economic situation isn’t any better: last quarter’s official growth rate, at 5.8%, was the lowest in five years, while the NSS’s estimated unemployment rate is at a 45-year high.
But you wouldn’t know this from reading the Budget. The lack of any meaningful discussion on the changing global environment or the slowdown in activity in India was glaring by its absence. Consistent with this view, the budget stuck to its interim deficit target in rupee terms, which implied a marginal lowering as a share of GDP from 3.4% to 3.3%. Not that I am complaining. Sticking to the deficit target was the right thing to do, but for entirely different reasons than I suspect the government believes in. Even with a lower deficit at 3.3% of GDP, the total public sector borrowing (including off-balance sheet funds) is likely to remain around 8.5-9% of GDP. This by itself is higher than the financial savings of households at 6.5% of GDP. Consequently, the public sector is already eating into corporate savings and any material recovery in investment would also mean higher foreign borrowing, and, in turn, a higher current account deficit.
The slowdown in India is not cyclical. If one simply charts India’s investment and exports as shares of GDP from the 1990s, the two lines are virtually indistinguishable. This correlation is the same for most emerging economies. Global trade has been the life blood of emerging markets, just as it has been for India. Private investment in India has floundered not because funding costs are too high or banks are hamstrung with bad loans or the exchange rate is too appreciated, as is collectively bemoaned. It is because global trade has languished since 2012 and is unlikely to recover to its past pace with the maturing of supply chains and the rise of anti-globalisation politics. Fiscal policy does have a role, but it is to restructure taxes and spending to encourage new domestic growth engines, not to increase the deficit.
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Separately, the Budget pushed for greater reliance on foreign funding to relieve the current liquidity pressures on the domestic capital market and the government is now looking to issue foreign currency bonds. This is a remarkable departure from India’s long-standing policy of avoiding the “original sin”. Issuing dollar-denominated government bonds will be successful, but it is unlikely to raise overall foreign funding. The buyers of local and foreign currency bonds are the same investors. With the government taking on the currency risk, these investors would be more than willing to shift to dollar bonds by selling their holding of local-currency bonds. Prior to the 2013 Taper Tantrum, India’s authorities also encouraged foreign funding by increasing the approval of external commercial borrowing (ECB) by corporates. We know how that story ended. Cannibalising the local-currency bond market and taking on currency risk isn’t a prudent strategy in today’s risky global environment.
The author is MD & Chief Emerging Market Economist, JP Morgan