The path to high growth

Subir Roy

Senior Economic Analyst

The Union Budget is being looked forward to with a greater than usual anxiety in view of the severe toll that the economy has taken because of the Covid-induced lockdown. The freezing of economic activity put India in the throes of a recession, with the official forecast anticipating a contraction of 7.7 per cent in the current financial year.

The country’s immediate economic future is in the hands of the government and the RBI, and their understanding of economics.

But the silver lining is that growth in the October-December quarter is seen to have already turned positive and various analysts expect a V-shaped recovery with growth in the coming financial year (2021-22), seen to be in the vicinity of 10 per cent. But this is a forecast and such estimates keep getting revised. So the policy challenge is to ensure that the nascent recovery is sustained. The most powerful policy instrument in the hands of the government for this is the coming Budget.

The single biggest challenge before the Finance Minister is to stimulate consumption at the bottom. This will revive the micro, small and medium sector which will restore jobs and reinforce consumer demand. Plus the sector’s output will revive the supply chain for the corporate sector.

But the most obvious restraint that the Finance Minister is subjected to is the need to go back to a reasonable path of fiscal restraint as the deficit has tended to run away in the current year. Compared to the Budget estimate of 3.5 per cent for 2020-21, at mid-year, the fiscal deficit was running at 115 per cent of the budgeted figure, and, according to one rating agency, could touch 7 per cent at the financial year-end.

If expenditure is reined in as part of the Budget to correct the fiscal deficit, it will mean saying goodbye to sustained growth. So the Budget must both put cash in the hands of the poor and some working capital in the hands of the small units which have run out of cash and had to close down.

But there is a way of not breaking the fiscal deficit rules – changing the rules. An idea being mooted is to stop looking at the safe level of fiscal deficit in terms of the Budget and start focusing on public debt as a percentage of GDP. This will give some headroom to the government, as by this measure, India is much better off at 62 per cent compared to other large economies like Japan (246 per cent), the US (106 per cent) and Germany at 89 per cent (all 2019 calendar year-end figures).

Related to this is the notion that the sustainable level of fiscal deficit is that which ensures the system is able to service the level of government debt. So long as you can do that, as the size of the economy goes up and yields robustly growing revenue, you are all right.

The creditor is of course the central bank or the government’s banker, Reserve Bank of India. The outlook here is mixed. Central banks across the world have followed hugely expansionary policies to counter the Covid-19 disruption and the RBI has been well behind them. This gives it a good bit of headroom.

But here again, the outlook is mixed. News reports indicate that the RBI is thinking of reining in the purse strings now that economic recovery seems on the way. But that will be a mistake. If right now credit gets costlier, we can say goodbye to sustained recovery.

Matters are not helped by the state of the financial sector, with public sector banks carrying a huge load of non-performing assets and pretty much the entire NBFC sector being in the doldrums. The NBFCs must continue to be given a lifeline so that they can keep extending a reasonable amount of credit and public sector banks must be recapitalised so that they can keep doing the same until they can be sold off.

The one positive reality is that the level of inflation, which is stoked by high fiscal deficit, is not causing concern and even as economic recovery is picking up inflationary pressures are moderating, retail inflation coming down to 6.9 per cent in November after peaking at 7.8 per cent in October. As inflation picked up in the first place because the economic standstill severely affected supply, a key policy aim must be to ensure that supply continues to pick up and inflationary pressures relent.

Additionally, the pandemic has hugely exposed the inadequacies of India’s public healthcare system so that global attention is focused on the way to bring it into some kind of shape. The internationally respected medical journal Lancet has set up a citizens’ commission with a formidable list of experts to chalk out a forward path for Indian healthcare in the next decade.

The state of publicly funded education is no better. Not only have schools and colleges been closed for months, the poor either do not have enough functioning smartphones or an adequate wireless network for the poor children confined to home to join online classes. Plus, the midday means programme, a lifeline for poor children, has disappeared in good part as schools have remained closed.

So the country’s immediate economic future is in the hands of the government and the RBI, and their understanding of economics. As right now, the RBI will pretty much do what the government wants, everything hinges on what the government thinks needs doing.

The government must go ahead and spend so that growth is sustained, economic activity picks up and government revenues do the same. The Finance Minister has promised to sustain public expenditure on infrastructure so that the multipliers work and economic recovery is sustained. She needs to take one more step, promise to give a big boost to social infrastructure as well, notably healthcare and education.

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