Furthermore, the share of capital expenditure in the government’s total expenditure can increase from the current 12% level with continued compression on subsidy expenditure (down from a peak of 2.6% of GDP to 1.6% of GDP recently) including through targeted subsidies (DBT).
The share of public investments in overall capital formation has been moderating since the 1990s, but it still remains significant at 7.5% of GDP. Especially in the area of infrastructure investment, the public investment contribution has been as high as two-thirds. To be sure, some fiscal space could be created on both the revenue and expenditure side with a concerted focus. For example, the continued push on direct and indirect tax compliance could enhance India’s tax revenues which, at less than 18% of GDP, are the lowest among the BRIC countries and significantly lower than the OECD average of 34% of GDP. Furthermore, the share of capital expenditure in the government’s total expenditure can increase from the current 12% level with continued compression on subsidy expenditure (down from a peak of 2.6% of GDP to 1.6% of GDP recently) including through targeted subsidies (DBT). While these two measures could easily add around 1% to 2% of GDP to the government’s capital expenditure, the public sector enterprises (CPSEs) could provide additional internal and extra budgetary resources to fund for capital expenditure.
Public capex demand
Between the central and state governments, it is the state governments that have been able to maintain their capital expenditure thrust for the last 25 years, with overall capital expenditure 3% of GDP in 2017 compared to 3.3% in 1991. The central government, on the other hand, has seen a decline in capital expenditure from 5.4% of GDP to 1.8% of GDP. However, if the investments of central public sector enterprises are combined with the central government’s budgeted expenditures, then the combined share could likely be above state governments. Not only is the capital expenditure of state governments higher, but the growth multiplier of state government capital expenditure is also higher as found by a recent RBI paper. The paper attributes the difference to concentrated spending by state governments as opposed to the broad spread of programmes pursued by the central government.
Stimulating laggard states
There is a wide variation among states in terms of factors of production and investment attractiveness. To lift the overall public investment by states, it is imperative for the lower-ranked states to modify their approach towards public investments and attracting private investments. Based on the 2017 NCAER State Investment Potential Index, Gujarat and Delhi have stayed at first and second rank for two consecutive years. Economic climate and infrastructure remain a significant determinant of a states’ ranking though there are certain notable exceptions. For example, while Andhra and Telangana rank poorly in terms of infrastructure, the overall investment potential ranking is within the top 5. Similarly, for states like Punjab, even though infrastructure is within the top 5, the overall attractiveness is poor.
Enhancing the fiscal multipliers
India is among the high fiscal multiplier countries as structural rigidities in the economy tend to enhance the response of fiscal shock/stimulus. Besides structural factors, the fiscal multipliers also get a boost in a period of negative output gaps and lower interest rates. With India’s growth likely to be 6.5% in FY18, we estimate the cyclical multiplier at 1.24 as per IMF methodology. Furthermore, with interest rates closer to the effective lower bound (repo at 6%), we also estimate the monetary condition multiplier at 1.26. As a result of these, we estimate the final fiscal multiplier at 1.1-1.6 for India, which is higher than China (0.6-1.1) and even higher than the United States (1-1.4) per the IMF study.
An RBI study found that the growth multiplier of state government capital expenditure is slightly above 2, while for the combined state and central government the growth multiplier of capital expenditure is around 1.3. This compares with the revenue expenditure multiplier of 0.6 and 0.37, respectively. Given the large difference in multipliers, the quality of fiscal expenditure by state and central government becomes important. Secondly, while the government remains committed to the fiscal consolidation efforts, the RBI study shows that a consolidation through an increase in tax revenue may have a less contractionary effect on GDP than a reduction in expenditure. As a result, a concerted effort to increase tax compliance, including through the roll-out of GST and direct tax reform remains important.
Crowding in private sector
An IMF paper estimated that in the post-liberalisation era, an increase in public investment of one rupee “crowds in” private investment of 0.37, 0.16, and 0.07 rupee after the first, second, and third year, respectively. Cumulatively, the multiplier stands at 0.6 for private investment, which enhances the attractiveness of public sector investments. Beyond this, a revival of PPP will still be necessary considering the large infrastructure deficit and investment needs. The NITI Aayog in its Three Year Action Agenda document recommends a course correction in the PPP model. Specifically, it recommends the constitution of an infrastructure committee headed by the Finance Minister or Prime Minister to resolve inter-ministerial policy issues/stalled projects, curb aggressive bidding by assigning weightage to different parameters rather than just financial offers, and strengthen dispute resolution mechanisms, among others. The deep dive into investment drivers suggest that the catalysts for investment recovery are present across the private sector (corporate deleveraging, resolution of bank NPAs, favourable external environment, low and stable interest rate regime) as well as the public sector (fiscal reforms on the tax front, enhanced expenditure quality towards infrastructure, focus on ease of doing business at sub-national level) and also FDI and household investments.
Encouraged by these findings, one could surmise that the investment growth, which slipped from 14.9% in the FY04-FY11 period to 3.4% in FY12-FY17, has the potential to rebound once again to 10%+ growth levels over the next 10 year horizon. Our own assessment of a similar investment growth profile (10%+) pushes investments from around 30% of GDP in FY17 to 35% of GDP in FY27. We also present an alternative high-investment growth scenario where the investment/GDP ratio is pushed up to 37%. In cumulative terms, the investments during the 5-year period of FY17-FY22 are likely to stand at $5 trillion and in the subsequent 5-year period of FY22-FY27 could be $9.6 trillion. This compares with the investment of $3.4 trillion in the FY12-FY17 period. A significant chunk of the investment, at around 7% of GDP, will be into the infrastructure sector which could amount to close to $1.1 trillion in the FY17-FY22 period and $2.0 trillion in the FY22-FY27 period.
(Concluding article of a three-part series)
Edited excerpts of Citi GPS’s Securing India’s Growth Over the Next Decade report