Rational Expectations: Budgeting right, to regain investor trust

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November 25, 2020 7:30 AM

Privatisation central to raising inadequate govt-spend, make PLI work, drop retro-tax cases, focus on exports

U.S. stock market, Wall Street, CBOE volatility index, stock market performance, S&P 500, nasdaq,The real issue is of the government’s will to do something, not the shortage of money.

The jury is still out on the size of the post-Covid stimulus but, as compared to a 12.7% growth projected for FY21, government expenditure was flat in Apr-Sept. Though it needs to be larger, given the collapse in private consumption and investment, the government fears a huge jump in the deficit will cause a ratings downgrade. As this column has argued earlier (bit.ly/398LiBU), if the productive capacity of the economy gets damaged due to inadequate spending, both the fiscal deficit and government debt will become unmanageable around the time of the next elections.

So, while finance minister Nirmala Sitharaman needs to indicate the glide path to fiscal consolidation in the next budget—from this year’s likely 7.5-8% level—it is vital not to compress expenditure too much as this will prolong the damage to the economy. CMIE puts the labour participation rate at 39.5% right now versus 42.7% in FY20, suggesting employment-intensive parts of the economy—like MSMEs—are in big trouble; CMIE also finds unemployment rates rising, which jells with the fact that 11.5 million more rural households were looking for MGNREGA jobs in October as compared to a year ago.

Though CMIE’s numbers are not comparable to the NSS Periodic Labour Force Survey report, the latter showed unemployment jumping from the historic 2-2.5% level to 6.1% in FY18, suggesting a massive shutting down of enterprises due to demonetisation. As it turned out, GDP growth in FY18 was 7% versus 8.3% in FY17; indeed, GDP growth continued to fall after DeMo, to 4.2% in FY20, suggesting the impact of sharp economic contractions can be quite long-lasting if not adequately addressed in time.

This does raise the question of finding resources to boost expenditure today, but the real issue is of the government’s will to do something (bit.ly/2HAvuNa), not the shortage of money. Extra foodgrain stocks with FCI, for instance, are worth around Rs 1.5 lakh crore and government equity in PSUs, including LIC, is worth around Rs 20 lakh crore; though the policy has yet to see the light of day, this is presumably why the FM spoke of the new strategic-sector PSU policy where only certain PSUs would be retained. A sustained privatisation policy will not just raise resources, it will unleash a wave of investor interest.

Government wealth in the form of land and other rights is almost infinite: that is why the new Delhi airport could be financed by just giving the GMR Group 250 acres of land with commercial building rights. And, with the private sector hardly borrowing, this year’s surge in government borrowing did not cause a spike in borrowing rates, suggesting the scope for increased government borrowing to fund greater expenditure remains high.

While looking at how to revive growth, the FM needs to go back to the national income identity Y=C+I+G+X-M, where Y is national income, C is consumption, I is investment, G is government expenditure, X is exports and M is imports. Private consumption (C) expenditure contracted 26.7% in the first quarter of the year, but it was slowing even before that; it grew just 2.7% in the last quarter of FY20 and, as job prospects look bleak—and they will look worse if the economy suffers permanent damage—the chances of an early recovery look slim, especially since the consumption boom was funded by high levels of borrowings.

Investment has been falling steadily, from 35.6% of GDP in Q2FY12 to 31.9% in Q1FY15 just before Narendra Modi became PM and to 22.3% in Q1FY21. One of the reasons for this is undoubtedly the anti-investor policies, the latest example of which is the government’s refusal to accept the global arbitration award in the Vodafone retro-tax case; indeed, while the government hasn’t yet formally contested this in court, the Supreme Court has just stayed the award given against its Isro in the Antrix-Devas case. The hounding of Monsanto, the refusal to fix telecom policy even after the government-created AGR disaster, not allowing oil and gas firms to charge market prices even though their contracts specify this … the list of unfriendly policies, including unpaid government dues of lakhs of crore rupees, is long.

While there have been some reforms in the recent past, these are far from enough; the UTI-T Rowe Price issue has finally been sorted out, privately-run passenger trains are to be allowed, commercial coal blocks have finally been auctioned, agriculture markets have been freed, and labour laws have been rationalised, among others. The government, in this context, will also point to the Rs 2 lakh-crore Production Linked Incentives (PLI) scheme it has just announced to stimulate investment; this includes the `40,000-crore one for mobile phone manufacturing that was announced earlier.

Getting the PLI-scheme on track, though, won’t be that easy considering that, in the case of mobile phones, the likely producer companies—Samsung and Apple—were first identified, the cost disadvantage of production in India, Vietnam and China were compared in detail, after which there were several rounds of negotiation to finalise the PLI number. It is not clear if the same sequence has been followed in the case of the 10 sectors for which PLIs were announced earlier this month; though ostensibly a domestic subsidy scheme, the plan is to design it in such a way that it promotes exports.

Whether the PLI works or not, PM Modi needs to know that the role of exports is critical. When C, I and G in the national income identity are constrained, increasing X is the only way out. In the economic boom years of 2003-08, JP Morgan chief India economist Sajjid Chinoy points out, India’s real exports growth averaged 17.8% annually while (public and private) consumption grew just 7.2%, and it is the former that caused the investment boom; a similar point has also been made by former chief economic advisor Arvind Subramanian. Boosting exports, however, is difficult if the overall plan is to raise import duties—as is happening now—as part of the atmanirbhar plan; indeed, India needs to be part of various FTAs/RTAs to boost exports and not walk away from pacts like RCEP.

If India has to return to a reasonable growth path, its first post-pandemic budget has to clearly spell out the steps on the path-to-recovery, and that includes a sustained effort to not just address investor concerns but to unleash fresh reforms. Modi and key aides have talked of using the Covid crisis to trigger reforms; they need to now deliver on this.

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