Strong macroeconomic fundamentals, rising concerns on the economic downturn, and the urgency to close the infrastructure financing gap, have created room for a fiscal stimulus
By Ejaz Ghani
Monetary policy has taken the lead in this global downturn, with successive rounds of interest rate cuts in both developed and developing countries. Borrowing costs have been lowered to offset the headwinds of this synchronised global downturn. It looks like monetary policy is running out of ammunition, given that low rates are yet to deliver a growth stimulus. Most central banks are not a in a rush to further lower interest rates. Reviving growth in a world of low interest rates requires a fresh rethinking of macroeconomic policies, to prevent growth slowdown from becoming an economic stagnation.
What can India do? The country has already implemented several rounds of monetary easing, and implemented major structural reforms—bankruptcy reforms, recapitalisation of banks, reducing corporate tax rates, improving doing business indicators—to revive growth. There is a rising concern that this has not turned around the economic downturn, and more needs to be done to reverse the declining trend in investments rates.
Can a fiscal stimulus stimulate growth? There is strong empirical evidence that countries that have sustained high public investment have also attracted more private investment. India’s investment in physical and human infrastructure is low as compared to other emerging market economies, and it is dismal when compared to China. A fiscal stimulus, aimed at scaling up investments in physical and human infrastructure, can enable India to accelerate economic growth, and create jobs for 10 million more people that join the labor force every year.
More than 500 districts in India suffer from low levels of investments in physical and human infrastructure. This has constrained the pace of economic growth and job creation. Most jobs are created by new firms, and less so by incumbent firms. Unfortunately, the entry of new firms in India remains low, despite improvements in ease of doing business indicators. A key barrier to the entry of new firms is poor physical and human infrastructure. This is much more important than doing business indicators (bit.ly/2NLtUHb).
Will a fiscal stimulus compromise India’s macroeconomic stability? Compared to other countries, India’s debt is substantially low as a percentage of world GDP. In India, private debt was 54.5 % of GDP and the general government debt was 70.4% of GDP, with a total debt of about 125% of GDP in 2017. In comparison, China’s debt was 247% of GDP. India’s debt is well below the average of most advanced economies and emerging economies.
A fiscal stimulus will increase debt, but it will also generate substantial assets. India has a lot of room to raise its net worth—difference between assets and liabilities—through investments in infrastructure. Although we hear horror stories of countries defaulting on debt, and being forced to cut back much needed investments, to close budget deficit, India’s macroeconomic policies remain on a strong footing.
India’s physical infrastructure financing gap is huge, and it is growing exponentially. It is estimated that India’s infrastructure financing gap is $1 billion a day. The biggest infrastructure financing gap is in the rural areas, where 60% of the population lives. The largest gap is in the transport sector, followed by power, water and sanitation, and telecommunications. India’s infrastructure financing gap will double, if we add investments in education and health, which deserve the same attention as investments in physical infrastructure.
How will investments be scaled up? A stimulus is not just about maximizing financing for development, but also changing the composition of financing, to increase the efficiency of investments. In the past, domestic banks and NBFIs have met 85% of infrastructure debt financing needs in India. In the future, India will need to also tap into the global markets.
Given the long-term nature of infrastructure projects, global institutional investors, and pension funds, can play a key role in meeting India’s huge infrastructure financing needs. The traits of India’s infrastructure projects, such as its market size, long-term steady revenue stream, and investment returns that exceed inflation, make them attractive for global institutional investors.
Although India has a long history in public private partnerships (PPP) in infrastructure investments, PPPs need to be brought up to global standards, to make infrastructure projects into an asset class, that can attract long-term investors. Problems of moral hazard and adverse selection, that have impeded private financing, can be overcome by reducing the opaque and diverse structures of projects, and providing information required by investors to assess the risk-structures. These problems can be resolved through governance and institutional reforms aimed at improving land acquisition, and improved contract and risk management. The future of PPPs lies in improving the preparation, design, and execution of projects, as well as better management of economic and social externalities. Project designs also need to give a bigger seat at the table to the gender agenda, as poor infrastructure adversely impacts women more than men. Given the rising concerns on climate change, more financial resources need to be allocated towards green infrastructure investments.
Policy makers will need to develop a comprehensive, collaborative, and a credible infrastructure investment plan and a capital market framework, to mobilise new funding. The framework needs to build a multi-year project pipeline, to attract and increase the availability of long-term finance, diversify the investor base, lower the cost of funding, and improve the risk-return profiles that match investors’ return expectations and liability structures. The central bank can also play a role in meeting the infrastructure financing gap, not just by targeting sovereign bonds, but also by exploring opportunities to buy debt issued by development banks that finance infrastructure projects.
A fiscal stimulus in India is timely, as this can lock in the current low global interest rates for decades to come, and absorb the glut in global savings, that is looking for new opportunities, and long-run returns. Strong macroeconomic fundamentals, rising concerns on the economic downturn, and the urgency to close the infrastructure financing gap, have created room for a fiscal stimulus.
The author is lead economist, World Bank. Views are personal