Amid growing discontent about the economy--corroborated by my impressionistic view based on Twitterati, most of whom are favorably disposed to the Modi government--a few prominent economists have come out strongly against any short-term fiscal boost. Some have predictably called for more "reforms." Let me state categorically, no amount of reforms will kickstart the private sector quickly. Corporate debt loads are still high, capacity utilization low, and banks are hobbled by NPAs. Businesses invest when they swamped with demand and credit is easily available. Of course, reforms help speed up investment when businesses are eager to invest, but they are a distinctly secondary condition. The famous 1991 reforms started soon after I joined ICICI in 1991. There was no magical pickup in capex. The new project pipeline was practically dry for the next several months. Capex did not meaningfully pickup until 1993-94.
Reforms mantra at this juncture is like the expansionary fiscal consolidation snake oil that was sold during the early stages of the European sovereign debt crisis. The idea was that government austerity and spending cutback could somehow be miraculously lead to faster economic growth. If this sounds too good to be true, it is. Essentially, it ignored the simple math of balance sheet constraints. if European governments were going to consolidate, that is run surpluses and bring down their debt, elementary accounting would imply that some other sector(s)--households, firms, or the rest of the world--had to run a corresponding financial deficit. Given the high levels of private sector debt in many of the beleaguered European countries at that time (excessive household debt among other things had caused the European crisis) and a global economy in which every country was bent on increasing its trade surplus, expansionary fiscal consolidation was an oxymoron.
India's situation is less parlous than Europe's in 2010-11, but to expect the corporate sector to lead to a robust acceleration in growth belies common sense. India's corporate debt-to-GDP appears low in comparison to some other countries (chart 1), but this is misleading. Ideally, corporate debt should be scaled to the sector's output. This data is not easily available for all countries. However, I do have it for the US. Although US corporate debt to GDP ratio is nearly 1.5 times India's, the corporate sector's share of GDP in the United States is close to twice that in India. And, US corporate debt is near records highs historically. Moreover, recent report from Thomson Reuters bears out the struggles of the corporate sector with debt. Unfortunately, there is no long history of India's corporate debt but BIS does publish total private nonfinancial sector debt, which includes households and corporates. The second chart shows total private sector debt to GDP. Household debt is about 10% of GDP today, so most of the sharp rise in the last decade reflects the runup in corporate sector debt. Today's indigestion is payback for the exuberance of the 2000s.
Meanwhile, capacity utilization is still low. In fact, L&T CFO in a recent interview said that he does not see a private sector recovery for two more years.
Tight Policy
Given India's faltering growth and weak capex, fiscal policy is simply too tight. In the past, when spending growth was as weak as it is now, the fiscal deficit was wider by about two percentage points of GDP, or about 3 lakh crores! I don't want to suggest that those policies were perfect and have to be emulated. Hardly. (India's policies have been often been procyclical--that is, the government has splurged when the going has been good instead of leaning against the wind. The second chart below shows government debt overlaid on private sector debt. You can see the tendency for both to rise together. Instead, the government should be playing a stabilizing role--cutting back deficits when the private economy is booming and supporting demand when the private sector is retrenching.) However, in the present situation, with the private economy faltering and government debt near two-decade lows, a dose of fiscal boost is what the economy needs.
Not to be left behind, monetary policy is even more of a Scrooge. the spread between nominal GDP growth--which capture both inflation and real growth--and the RBI repo rate is near its lowest levels of the past 17 years, indicating that policy is tight. An easier monetary policy will spur household credit offtake--for consumer durables and housing. India's household debt is very low and household borrowing can help spur economic revival. Fiscal policy measures to support low-income housing combined with interest rate cuts can kill two birds with one stone.
Few caveats to keep in mind:
ReplyDeleteThere is fiscal stimulus already set in motion - seventh pay commission (Union and States), farm loan waivers.
With States' fiscal deficits taken into consideration, the case for fiscal stimulus narrows.
India too has a major unreported or under-reported problem with under-provisioned government pensions. They are not reckoned with.
How fiscal stimulus is administered and what it is spent on matter. UPA won elections and 'revived' the economy with a fiscal stimulus in 2007-08 and 2009 onwards. The economy paid a heavy price for it. So, what is the objective function that is being optimised or maximised with a fiscal stimulus and over what horizon?
The prospect of a 'low-quality' fiscal stimulus with medium to long-term costs is non-trivial, considering the rising proximity of 2019 elections.
A very well presented argument Sir, thank you. My two cents, if I may:
ReplyDeleteLike the first commentator suggested, it can be argued that a stimulus has already happened, through largess to government employees and widespread loan waivers of farmers. If that has not revived growth, then perhaps the answer lies elsewhere.
India's manufacturing capacity utilisation has come down to 75% from peak 82% a few years back. Does this not suggest that there is a fundamental lack of demand and perhaps not a function of government stimulus.
While your point on boosting consumer loans is well taken, Asian economies are unique in the sense that we are more savings oriented than spending oriented. As a % of GDP, personal/ retail lending is at 10-11%, which is close to the level reached during the boom of 2007, if I recall. Anecdotally, we are most comfortable with borrowing for buying a home. This is reflected in mortgages accounting for more than 50% of the personal loans o/s in India. But now housing is slowing down due to multiple reasons. If housing prices soften, even serious buyers will hold their demand in anticipation of further weakening. This is a double edged sword, as when housing prices were rising, people bought even at unsustainable levels thinking that they will always keep going up, and now that they are falling people aren't stepping in to buy waiting for that "another 5% correction" :)
Anyway, coming back to the point that I was trying to make, the issue is not that there is no fiscal stimulus, but that the stimulus is not in a form that will kindle the oft-repeated "animal spirits". To this end, a sharp cut in RBI rates will send across a message that asset prices are on the rise and spur demand in the housing market. This will fuel demand for various products and have a positive spillover effect onto the manufacturing space. So the catalyst, in my opinion, will be a high visibility reform that has a more psychological impact than necessarily a financial impact. Sharp cut in rates is an example of that. Another could be raising IT exempt slab to say, Rs 1 million.
The current moves by the government are understandable. I always say, the poor vote on actual benefit and the better off on perception. Modi has spent a greater part of his tenure in delivering the actual benefit to the section that values it. I am hopeful that he will now win the perceptional battle as well in the next year to prepare himself for 2019.
What about reviving agriculture which employs >50% of the workforce. Manufacturing and Services are saturated as can be seen by lack of utilisation and jobs. Boost the rural economy by creating smart agri hubs, refrigerated cold chains, storage, horticulture, food processing, healthcare and education facilities. This will create jobs. Most entering the workforce are from rural areas.
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