One statistic explains much of the downward trend from the peak growth rate of 9 percent averaged between 2003 and 2012.
Economists would almost universally agree that fiscal discipline is a good thing. No government should aspire to live beyond its means. If it does, the consequences can be severe: higher inflation, higher interest rates, low private investment and lower growth. India’s current government has justly been praised for its fiscal restraint. It’s reduced the overall fiscal deficit and reoriented spending away from wasteful programs such as fuel subsidies and toward more productive investments in infrastructure. What it hasn’t done, however, is deliver the sustained high growth of over 8 percent that India needs. To do so may require loosening the purse strings.
It’s important to remember why the Indian economy is struggling. Some analysts argue that the slowdown is a recent phenomenon, sparked by the government’s decision last fall to withdraw 86 percent of banknotes from circulation and the introduction this past summer of a nationwide goods-and-services tax. Yet, while both measures may have disrupted growth in recent quarters, the economy is likely to return to 6.5 percent growth once it has adjusted. Getting to 8 percent will be harder, because of factors that are deeper and more protracted.
One statistic explains much of the downward trend from the peak growth rate of 9 percent averaged between 2003 and 2012. The ratio of private investment to gross domestic product was around 38 percent in 2006-7, in the middle of that run. Ten years later, the ratio has plummeted to 28 percent. Almost the entire fall took place before the current government assumed power. It hasn’t recovered since, despite a stable macroeconomic environment of low deficits and low inflation.
Karl Marx is sometimes said to have understood capitalism better than he understood communism. Marx knew that capitalism moves in cycles of boom and bust, or upturn and downturn. India is suffering a down cycle characterized by the fall in private investment and a slowdown in exports (two crucial growth engines) over several years now. The bust began toward the end of the last government’s tenure, when growth collapsed amid a spate of scandals and policy paralysis. Companies that had risen on the high tide of rapid growth suddenly found themselves over-leveraged, struggling for profits (or in deep losses) and short of opportunities.
A greatly weakened global economy, buffeted by the the 2008 crisis and troubles in Europe’s so-called PIIGS economies (Portugal, Italy, Ireland, Greece and Spain), hammered exports. The fact is that the Indian economy needs to go through a cycle of firms and even individuals deleveraging and scaling down, adjusting to the new reality. The question for the current government is how best to mitigate the pain of that process. Marx’s solutions were a disaster. But a later economist, John Maynard Keynes, came up with a better way to manage and moderate cycles in the short run, by using monetary and fiscal policies in a counter-cyclical fashion.
The Reserve Bank of India, believing that inflation (at its most benign in many years) is a greater threat than sluggish growth, hasn’t been much help on the monetary front. The bank has resisted cutting rates, despite signs of an extended slowdown. Rather than lamenting that fact, the government should use the only other tool available: fiscal policy. If fiscal restraint hasn’t revived private investment, then perhaps spending more will help to “crowd in” such investment. Jumpstarting growth would help relieve the problems of stressed assets and struggling firms, which is the only way to encourage them to invest more.
One of the reasons this is easier said than done is because governments don’t always abide by the counter-cyclical principle when there’s an upswing or boom. When growth is healthy, the government has to be diligent about keeping its fiscal policies in balance or surplus, rather than deficit. That leaves cushion for the inevitable downturn. Unfortunately, the previous government spent heavily on wasteful schemes at precisely the moment when the growth cycle was rising. Nor is the central bank blameless. The RBI has often been behind the curve in raising interest rates when a boom comes, which results in overkill during a downturn. The test of a good policymaker is to get counter-cyclical policies right.
A tight fiscal policy shouldn’t be an end in itself. While India has a history of fiscal imprudence, that shouldn’t commit policymakers to a target with no regard for the economic context. Of course, fiscal expansion has to be carefully thought out. It cannot mean a proliferation of subsidies, for example. But it could mean greater investment in affordable housing schemes, which would have significant multiplier effects on the economy. It could mean fast-tracking other infrastructure projects, whether roads, flyovers or urban transportation. It could also mean rationalizing, further simplifying and lowering GST rates so that consumption isn’t adversely affected. A small dose of rationalization was administered last week. There’s room for more.
Such measures would require only limited relaxation of fiscal targets and not an irresponsible spending spree. The government has pledged to maintain the fiscal deficit under 3.2 percent of GDP: Why not raise that to somewhere between 3.5 percent and 3.8 percent? In an ideal world, the economy wouldn’t go through cycles. In the real world, even the best-structured economies see ups and downs. Macroeconomic policy needs to smoothen the cycles at both ends. Views do not reflect the views of NITI Aayog or the government of India.