New fiscal mindset key to reviving growth

Published: July 5, 2019 2:36:41 AM

Many long term investors, foreign and domestic, such as pension funds and insurance companies may be interested in buying recycled assets, especially those who are averse to construction risks but do not mind operating risks.

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By Pranjul Bhandari and Aayushi Chaudhary

India’s growth has hit a soft patch, battling structural, cyclical, domestic and global headwinds, all at once. It started with the fallout in the NBFC sector. While bank credit growth has picked up since, NBFC credit is slowing. And, to the extent NBFCs were buoying growth in the fastest growing sectors, overall economic growth is at risk.

The global environment is not helping either. India is more open and more affected by global issues than many believe (see graphic). India’s exports have been sluggish, and the complex issues dragging global growth lower are likely to impact India further.

India’s potential growth (defined as the maximum growth possible without stoking inflation), has fallen from 8% a decade ago to 7% now. There are three main drivers of growth-capital, labour and Total factor Productivity (TFP). Recent reforms, such as digitisation and the GST, have focused primarily on raising TFP. In order to raise growth from here, capital and labour cannot be ignored.

To be fair, growth could inch up in 2H2019, with election-related uncertainties fading and the RBI easing. But, that can only take growth closer to 7% from sub-6% in the quarter ending March 2019. Anything higher will need reforms which augment capital and labour.

With growth slowing, there are big demands on the upcoming budget (on July 5) as well as the next few Monetary Policy Committee (MPC) meetings.

There is a sense that the cost of capital in India is very high. The simple solution is to cut the repo rate. The RBI has already cut rates by 75bps in 2019, and based on their preferred range for real rates, there could be a maximum of 75bps more in rate cuts. For now, we go with the midpoint of the (25bps to 75bps) range. We expect 50bps more in rate cuts, spread over 4Q2019 and 1Q2020, taking the repo rate to 5.25% by March 2020.

But repo rate cuts are just one part of the cost of capital. The other part is transmission of repo rate cuts. To get a better handle, we divide the cost of capital into three parts—(i) the repo rate, (ii) the spread between the repo and the G-Sec rate, and (iii) the spread between the G-Sec and the corporate bond yield. The G-Sec spread and the corporate bond spread remain elevated.

The former, in our view, is a consequence of elevated public sector borrowing. At over 8% of GDP, borrowings are exhausting the market. The timing is not desirable either. Borrowings are rising around the time net household financial savings have fallen; the ‘investible surplus’ available for private investment has shrunk considerably (see graphic).

The bottom line in clear-while there is some space for monetary easing, there is no space for a higher fiscal deficit and higher borrowings.

And yet, there is scope for imparting a positive fiscal stimulus to growth without endangering the fiscal deficit target. The way out is the idea of “asset recycling”. This is not a new idea. Like many other reform ideas, it has been incubating over the last few years, and we think its time has come.

Asset recycling includes disinvesting government stakes in companies, but is not limited to that; it includes the selling of several kinds of government owned assets, such as roads, ports, airports, electricity transmission and distribution companies, etc. The proceeds from these sales can be used in the creation of new assets-news roads, new ports, etc-which can be recycled again, when completed. As such, the same pot of money is recycled several times over, without endangering the fiscal deficit, and yet upgrading India’s infrastructure.

Many long term investors, foreign and domestic, such as pension funds and insurance companies may be interested in buying recycled assets, especially those who are averse to construction risks but do not mind operating risks.

Asset recycling is not a public private partnership (PPP) in its original form, where the government and the private sector join hands in construction. Instead, here the government constructs and sells off to the private sector thereafter. How large could the growth impact of asset recycling be? Our calculations show that, at the promised 3.4% of GDP central government fiscal deficit for FY20, the growth impulse is zero. If, say, assets worth 1% of GDP are recycled this year, assuming a capital expenditure multiplier of 1, growth could rise by 1 percentage point.

Labour reforms, while essential to India’s growth revival, are complex, and their growth pay-off will only trickle in gradually. Investment revival can be a tad faster. Given a high fiscal multiplier for public capex, it can “crowd in” private capex over time, if done in a fiscally responsible way. India’s best bet to raise growth is by raising the investment cycle, and private investment (which makes up 75% of all investments) can only be raised by creating a conducive environment by stepping up public investment in a fiscally responsible way. This can only happen through asset recycling.

(Pranjul Bhandari is Chief economist, India, HSBC Global Research. Aayushi Chaudhary is economist, HSBC Global Research. Views are personal)

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