Wanted: A Mini-Budget And A Big Fiscal Stimulus Of Rs 1-1.5 Lakh Crore From Modi Govt

The Indian economy is in a tailspin after five quarters of falling gross domestic product (GDP) growth rates, the lag effects of demonetisation, the initial uncertainties involved in implementing the goods and services tax, and the prospect of future shocks when banks start resolving their bad debts (which means they will take bottomline hits).

It should thus be a no-brainer that the remedy is a fiscal stimulus. This is not the time for fiscal fundamentalism. The last thing you need when GDP growth is down to a three-year low of 5.7 per cent is a pro-cyclical fiscal consolidation manoeuvre that makes things worse. Even though the fiscal deficit as of July looks scary, with 92 per cent of the year’s target accounted for, one can expect Goods and Services Tax (GST) to make up for some of the slack. Its current level of fiscal deficit cannot be a reason to let the fiscal Taliban rule government spending.

The Reserve Bank of India may not oblige the government with rate cuts, but the ball now is squarely in Finance Minister Arun Jaitley’s court: it is not the interest rate that is going to get the economy out of trouble, but a fiscal stimulus. Among the four engines that drive growth, one is missing in action (corporate investment), two are weak (exports and private consumption), and the one that is firing (public investment) is about to hit speedbreakers erected by the United Progressive Alliance (UPA).

Contrary to what people may believe, the National Democratic Alliance (NDA) is not behaving like the UPA where it matters. The UPA adopted huge fiscal stimuluses when the economy was firing on all cylinders; the NDA is doing the opposite, hitting the brakes when the economy is slowing.

During the UPA regime, when growth was in top gear, P Chidambaram and Pranab Mukherjee offered two major fiscal stimuluses – a huge Rs 8.4 lakh crore subsidy on petroleum products spread over its 10-year tenure, and a specific Rs 1.8 lakh crore cut in excise when Lehman sent the world economy tumbling. But the economy did not need the first stimulus, and the second one lasted long after it was needed.

During NDA-2, the broad thrust of fiscal policy has been deflationary. In the first three years, minimum support prices (MSPs) have been low and non-inflationary. More importantly, tax policies have been deflationary too. In oil, for example, as we had noted before, between 2013-14 and 2016-17, central taxation on petroleum products rose by more than 150 per cent from Rs 106,090 crore to Rs 273,502 crore. States boosted taxes by 23 per cent, from Rs 152,460 crore to Rs 188,618 crore.”

This means over Rs 2 lakh crore of additional taxes have been collected from the petroleum sector alone in three years. All this money went towards fiscal consolidation, and hence proved non-inflationary. Contrast this with the Rs 180,000 crore stimulus by UPA after Lehman, which sent inflation soaring past double-digits since it came over and above subsidised petro-goods, and high increases in MSPs.

Other policies, including the collection of huge premia on spectrum and coal mine auctions, also dented the corporate sector’s cash reserves, adding to the investment deficit.

It is time for the NDA to change tack. We now need a fiscal stimulus of the magnitude of Rs 100,000-Rs 150,000 crore, much of this going to strengthen banks and increasing public investments in infrastructure.

Here is what the government must do – and not do.

First, it must offer a one-shot Rs 80,000-100,000 crore recapitalisation of public sector banks, which will allow them to write off or reschedule bad loans, which now exceed Rs 7 lakh crore. This will enable banks to clean up their balance-sheets and start lending.

The fiscal fundamentalists will say that this will bust the fiscal deficit target of 3.2 per cent this year. It will also increase bond yields, since a large amount of this deficit will be financed from market borrowings. So be it. The problem right now is not the level of rates, but lack of investment. If the big bond issues do not find takers, the Reserve Bank of India (RBI) can anyway mop them up, and grow its own balance-sheet. Let’s not forget, one of the reasons why the RBI had to cut dividends to the government last month was because it was not earning enough on bonds issued by the government. This huge borrowing by the government to recapitalise banks is thus good for both the central bank and the banks it is supposed to supervise.

Another impact could be on the exchange rate, but a decline in the rupee is important to boost exports and strengthen corporate margins on exports. In July, for example, while merchandise exports grew by 3.94 percent, in rupee terms exports shrank by 0.32 percent. This shows that exporters are earning less than before despite exporting more. It does not help banks if their borrowers are earning less than before.

A large government borrowing programme for this year, meant to provide a stimulus, will have as many positive consequences as negative ones. It is worth the risk when the economy is tanking, especially when inflation is benign.

Second, the government needs to change the UPA-era Land Acquisition Act by hook or by crook to speed up the highways building programmes. The UPA Act has more than doubled land acquisition prices, from under Rs 1 crore a hectare to over Rs 2 crore. One hectare of land roughly builds you one kilometre of highway. This means every hectare of land acquired is creating one or two rural crorepatis, but also killing the possibility of making highways viable even in the long term. So new jobs won’t be created fast enough to enable rural youth to shift from agriculture to non-agricultural work. Without a spike in real estate and infrastructure construction, there is not a snowball’s chance in hell that jobs growth will improve.

So, to put it simply, more money should go into infrastructure, and the Land Act needs changing as of yesterday to improve the terms on which public invest in infrastructure can be made.

Third, there are also things the government must not do. For example, there is no point in forcing weak banks to merge with strong ones, unless dictated by strong complementarity. Right now, the mergers are being driven not by the logic of scale or synergies, but to economise on equity contributions from the exchequer.

This is not the time for the government to be parsimonious about contributing capital to strong banks, and forcing the weaker ones to slowly downsize, or become narrow banks which lend less and focus on raising cheap deposits. Weak banks can remain afloat merely with the promise of a government guarantee on deposits, and they should be selling their good assets at a profit to stronger banks which can expand lending, while at the same time focusing on retrieving bad loans.

Weak banks should become deposit-takers, earning fees from originating loans on behalf of strong banks, while focusing on loan recoveries.

Here is the core message: we need a fiscal consolidation holiday, and a mini budget stimulus to get the economy out of the ditch.