P Vinod Kumar and Suresh Babu M
Indian economy needs higher public spending: Economists and policy makers were busy discussing the shape of economic recovery in India not so long ago – with the fragile uptick being likened to almost every letter in the English alphabet. Suddenly, the debate went out of currency as no one seemed to be sure of what is in store for the economy. One of the reasons could be the impending third wave of the Covid-19 pandemic and the advent of the delta variant of the deadly coronavirus. The uncertainties over the speed and shape of the recovery are pretty evident in the August 6 monetary policy statement and the accompanying commentary on Indian economy by the Reserve Bank of India.
A nuanced reading of the RBI document leaves enough hints that despite 100 odd Covid-19 response steps in the past 14 months, the monetary policy did not make an impact on the growth trajectory. It is time for the fiscal policy to take over from where the monetary policy has left to get the Indian economy back to the pre-pandemic levels. In other words, managing the pace of economic growth by adjusting the cost of borrowing does not work in a demand constrained economy. Therefore, policy makers should get their reasoning right and align their acts with the economic realities by junking the concept of the fiscal glide path.
Indian economy needs aggressive public spending
To its credit, the RBI has made it clear that it is willing to let inflation overshoot its comfort zone and remain accommodative till broad-based growth takes root, so that the benefits of growth reach every pocket of the economy before policy normalization.
The urgent need for fiscal action also stems from the fact that the estimated 9.5% economic expansion in the current fiscal is partially attributed to the base effect as the economy dived by 7.3% in the previous fiscal. Also, there is a counter narrative to the growth optimism with an economic think tank seeing output measured by gross value-added (GVA) returning to its pre-Covid levels only by the end of this decade. Nobel laureate Abhijit Banerjee went on to peg the FY 2021-22 GDP expansion of Indian economy at 7% or even below, unless the Union government stepped up its spending to revive demand.
The narrative on economic growth is finally seeing a paradigm shift with more and more experts favoring a higher level of public spending over the so-called virtues of austerity despite the random increase in some of the high frequency indicators. This is because the income multiplier on the demand side will translate into higher consumption levels, boosting aggregate demand quickly. Though investment-led growth may be an optimum option, its effect on the economy will be slower compared with demand-boosting measures.
Need to revive consumer demand
This makes a strong case for an expansionary fiscal policy especially when employment generating services sectors and micro, small and medium enterprises are yet to recover from the impact of demonetization and the waves of pandemic. It is no longer a secret that the Indian economy started losing the plot ever since demonetization ripped through the cash-heavy sectors such as services and small and medium industries.
Reading of sector-wise growth figures shows that services sector still remains in the negative zone compared with historic averages while more and more SMEs have been pushed to the stressed zone. The second wave of Covid-19 has also left its trail of damage in the rural hinterland and an uneven monsoon in many parts of the country could upset rural income and consumption levels.
Such undisputable facts reinforce the need for a paradigm shift in policy making with the government doing whatever it takes to speed up the economic recovery. Arguably what is preventing the policy makers may be their misplaced concerns about budget deficits. However, this line of thought is fast losing ground with democratically elected governments, central banks and multilateral agencies pivoting to the virtues of public spending and the virtuous cycle it can create.
Govt must shed fiscal deficit worries
It is now an established fact that public spending would lead to higher and broad-based growth in an economy hit by income shocks and demand destruction. Shift in economic policy will also shield the financial system from distress. With rise in income, households will pay their debt, installments on loans, and rents. This is important now as the government’s much touted stimulus packages are adding to the growing stress in retail loan of lenders. Had the government tuned its policy towards restoring incomes of households, such slippages could have been avoided.
Balancing the government budget at a time when millions of household budgets are in imbalance may prove counterproductive for growth. The stubborn among the deficit vigilantes may look for an acceptable solution by thinking about an affordable level of fiscal deficit which while spurring effective demand will also support a broad-based recovery.
Affordable fiscal deficit implies deficit that remains at an affordable level in relation to domestic savings, tax revenue and capital formation, all being a function of income levels and effective demand. Equally important is the issue of how to find a pragmatic answer to the question of financing the incremental deficit incurred while supporting household income levels, unmindful of size of the deficit.
Monetizing deficit by printing money might not be the solution. The Union government could cover its deficit by stepping up its market borrowings. With an accommodative central bank, the government could raise the required amount either by tapping into the Rs 9 lakh crore (Rs 9 trillion) excess systemic liquidity, the amount RBI is now buying from various lenders through its reverse repo window at an interest rate of 3.5%.
In that way, the massive government borrowing with a pre-set time table will not upset the bond market apple cart as it will not lead to a spike in yield curve. Nor will it crowd out the private sector from the market by starving them of funds. A bonus comes attached to such a policy stance since it will save the RBI the unenviable task of policy normalisation by an abrupt lift off in rates. It will also save markets from throwing the so called taper tantrums.
Thus, the most effective way to get the economy back on track is to step up public spending. Though the onus is on the Union government to kick off a big-ticket spending programme, other economic agents including individuals and the private sector should follow it. So far, the track record of every economic agent is far from satisfactory. Instead of worrying about gross fiscal deficit, policy makers should think of gross fiscal responsibility, meaning higher level of spending for higher level of economic growth and improved standards of living.
(Suresh Babu is professor at Indian Institute of Technology, Madras. P Vinod Kumar is a Kochi-based independent economist and columnist. Views expressed are personal.)