As the finance minister prepares to announce the budget for fiscal year 2017, expectations are muted compared with a year ago. The hopes spurred by Modi’s election have quietly given way to disappointment as the economy has failed to accelerate and job creation has been anemic. Meanwhile, storm clouds are gathering over the global economy, and India is already feeling some of the draft. It is time for the finance minister to jettison fiscal consolidation and go for growth.
An expansionary budget is needed to clear the air of gloom, to insure against a probable global economic downturn, and to speed up the corporate and bank balance sheet repair. Indeed, the IMF — once the bastion of fiscal rectitude — has called for a coordinated fiscal stimulus by the G-20. Yet, by all indications, Mr. Jaitley is likely to hew the path of incrementalism, loosening policy somewhat relative to existing commitments but still aiming to deliver a lower deficit next year.
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Judging by real GDP growth, the Indian economy appears to be doing fine, especially in relation to the rest of the world. However, almost every other indicator —industrial production, capacity utilization, capital spending, corporate earnings, the stock market, nonperforming loans at banks — suggests that the economy is treading water rather than growing robustly. What these indicators are portraying, in contrast to the message conveyed by GDP, is closer to the felt experience of millions of Indians, Indian businesses, and investors.
There are four reasons why the economy has failed to accelerate over the past two years: 1) the weakening global economy and declining global trade has hurt exports, 2) corporate sector deleveraging has crimped capital spending, 3) bank balance sheet problems have hindered credit expansion, and 4) fiscal policy tightening has compounded the drag on the economy.
Looking ahead, the global economy is perilously poised, with a recession looking increasingly probable. China and the other emerging economies, which are the epicenter of the current global problems, appear to be headed for a hard landing. Their problems have already engulfed the developed economies with heavy exposure to commodities, such as Australia and Canada. Germany, the powerhouse of Europe, has shown noticeable deterioration in the past couple of months. In the United States, growth slowed to a crawl in the fourth quarter, and more recent data, on balance, shows further weakening.
A global recession would further dent India’s exports, cause foreign direct investment to decline, and hurt remittances. In addition, vastly tighter global financial conditions would hurt the ability of Indian businesses to borrow in the international markets. Portfolio investment flows, which already reversed in FY 2016, are likely to turn further negative, which will weigh on the stock market and executives’ confidence.
Meanwhile, domestic business capital spending is likely to keep declining. Deleveraging still has some way to go. Moreover, with weak profitability and low capacity utilization, the corporate sector has no great incentive to invest. Lastly, banks are struggling with elevated levels of non-performing loans and inadequate capital, and are in no position to finance a private sector recovery.
Under these circumstances, if the finance minister persists with fiscal consolidation, we will be lucky if the economy does not decelerate sharply. Last year, we had the good fortune that oil prices plunged dramatically, which boosted the economy and offset other negatives. Over the next 12 months, even if oil prices decline further — likely in the event of a global recession — the benefits will be proportionately smaller and outweighed by other negatives. The finance minister should not just eschew fiscal consolidation, he should announce a sizable stimulus to take out an insurance against a global economic tsunami.
Any call for fiscal expansion is bound to stoke concerns about inflation. However, under current conditions, fears of fiscal deficits fueling inflation are misplaced. Consider the period 2000-2002, which is in many ways similar to the present experience. The Dotcom bust caused a global recession, the domestic corporate sector underwent balance sheet consolidation, and the government ran substantial fiscal deficits, propping up the economy. Government debt as a percentage of GDP increased, peaking in 2004 at about 63% for the central government — considerably higher than the current level of 46% of GDP. Yet, inflation remained low because, then, as now, oil prices were low and global commodity and food prices were subdued.
Ideally, fiscal stimulus should boost the economy while building capability for the future and allaying financial market fears of inflation. Infrastructure investment is a no-brainer. If “Make in India” has to go beyond a slogan, India has to dramatically enhance its transportation and power networks. Swachh Bharat could also do with more budgetary support and not just depend on the heroic work of volunteers. The government can also play a crucial role in catalyzing transformational technology. Perhaps investing in achieving a breakthrough in thorium power could have spillover benefits for the industry, apart from, of course, securing our long-term energy security.
Everybody has a wish list. The only thing that matters is what the finance minister is going to do. Judging by the Modi government’s generally incremental approach to policy thus far, my best guess is that the finance minister will continue with modest fiscal consolidation. The budget is unlikely to cheer anybody but, given the diminished expectations, it is not likely to evoke widespread disappointment either.
