Chance to put the economy back together

Aunindyo Chakravarty

Senior economic analyst

In another week, there will be another Budget, or bahi khata, as the Modi regime now likes to call it. The government will tell us what it will spend on and how it will raise the money to finance that spending. Never before, since the so-called ‘policy paralysis’ days, has there been a more crucial Budget.

It comes at a time of deep economic slowdown. The government’s own estimates suggest that the economy is going to grow by just 5% this fiscal. That number looks optimistic compared to the IMF’s latest projection, which now says India will grow by just 4.8% in 2019-20. The big problem for the government is that both engines which drive the economy — investment and consumption — are failing. The Finance Minister will have to conjure up a magic potion to fix them. The Budget is one important tool to get things back in working order.

Investment has two parts: government and private. Private businesses invest either when there is a chance of earning profits or of increasing the value of their businesses. From the world of startups, we know that the two do not necessarily go hand-in-hand. After all, there are multi-billion-dollar companies, which make multi-billion-dollar losses.

Companies invest when they see increased demand for the goods and services they supply. When the demand increases, they first run their machines for longer and run extra shifts with overtime. In other words, they increase capacity utilisation. If demand keeps growing, more capacity needs to be added. That is when new machines are bought, factories set up and new office space is added. The exact opposite happens when demand shrinks. A few machines are switched off and contract workers reduced. If the company begins to lose money, it sacks people and shuts down the shop-floor. Finally, if the losses mount, the company is either sold or it goes out of business.

There is, now, no disagreement that demand is at a new low. Which is why, corporates are not investing in building capital. A large chunk of their retained profits is going into stock market and other financial investments. In fact, India Inc is not doing well, even after the tax sops given by the Modi government.

Data compiled by CMIE, for over 4,300 listed companies, shows that revenues dropped by 1.6% and net profit by 14.4% in the second quarter of this fiscal, compared to last year. If one takes out financial companies, like banks, NBFCs and insurance players, sales dropped by 5.7% and net profit was down by 28.3%. If you deduct the inflation rate from this, the drop in real income is even starker.

Understandably, the private sector is neither investing in new projects nor are they hiring more people. In the first two quarters of this fiscal, new project announcements amounted to only about Rs 1 lakh crore per quarter. This appeared to have jumped dramatically to Rs 4.5 lakh crore in the third quarter. But, a closer look shows that 80% of that came from one questionable aircraft order, two power projects and one refinery. Remove that, and the net new project announcement drops back to below the Rs 1 lakh-crore mark.

The latest round of CMIE’s survey shows that unemployment is at record levels. Among those in their early 20s, who are looking for jobs, 44% are not getting any. Educated unemployment is even higher: 63% of graduates between the age of 20-24 were found to be unemployed in the September-December 2019 jobs survey. This is a time-bomb which the government needs to defuse immediately.

Government expenditure is the only way out right now, both to increase the investment rate and to stimulate consumption demand. But the government has been trying to run away from this task. It still believes in the neo-liberal principles of reducing the state’s presence in production. So, it is desperately trying to privatise PSUs, while at the same time, cutting funds to public sector enterprises that are unlikely to get buyers.

‘Modinomics’ is also a prisoner of fiscal fundamentalism — the belief that governments should continuously keep their fiscal deficit down. Neoliberals who propagate this idea can never explain to you why they also encourage corporates to borrow huge amounts and invest to expand their business. If private companies can leverage their balance sheets multiple times to grow their businesses, why can’t a government do the same to expand the economy?

If Modi Sarkar is serious about fixing the economy, it will take this opportunity to set aside the FRBM Act, which hobbles its ability to spend. If it can use its massive mandate to steamroll amendments in Parliament, it can do the same with FRBM. This will allow Team Modi to increase its spends significantly and give a 360-degree stimulus to the economy.

The Manmohan Singh government did it to tackle the global economic crisis of 2008. The fiscal deficit was increased to 6% in 2008-09 and was budgeted to be 6.8% in 2009-10. This resulted in a GDP growth of 8% in 2009-10, at a time when the world was slowing down, followed by 8.4% in 2010-11. Some economists believe that the 2010-11 growth would have been higher had the UPA government spent all the money it was budgeted to do in 2009-10. Instead, it tried to dial down the fiscal deficit, ultimately ending at 6.4% instead of the budgeted 6.8%. Fiscal fundamentalism made the UPA government bring the fiscal deficit down to 5.7% in 2011-12 and further down to 5.2% in 2012-13. The result was a massive drop in the GDP growth rate (4.5% in 2012-13 and 4.7% in 2013-14).

The question is whether PM Modi will show the guts to take on global finance and go against their prescriptions. Increasing the fiscal deficit will be met with threats of downgrades by big rating agencies. This will increase the risk premium for Indian equities and might make FIIs pull out their money from the stock markets. It is up to Mr Modi to decide whether he wants to keep the bulls of Dalal Street happy or revive the real economy.