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Economy needs a segment that can spend and spend big

Posted by : Ravindran on | Apr 20,2015

With the right stimulus, the Indian economy can do wonders


India’s economic growth is anaemic despite the economy’s fundamentals, inherent strengths of a youthful demographic, skilled workforce, strong manufacturing sector and an exceptionally healthy services sector. There is, however, a bigger danger. Growth might remain muted for a long time unless the government can step in and control the slowdown. The economy badly needs investments. Yet, at the moment, all the three key levers of economic significance—the government, the private sector, and consumers and households—are holding back fresh investments and/or increasing savings. The government, which had been utilizing its funds till three years ago, is not making fresh investments in a bid to control the fiscal deficit. The private sector is de-leveraging as factories are sitting on unutilized capacities, or is not making fresh investments due to lack of growth. Households are conserving cash and holding back consumption and spending much less on new purchases.


The key question now is, if all these three vital segments are conserving cash, then where are the investments going to come from? The economy badly needs a segment that can spend and spend big.


The government can give that little fillip to the economy. It can take the investing mantle onto its shoulders and make the big investments to spur the economy. Sentiment needs to be turned around on a priority. To shift the economy into high gear, the government needs to stretch its fiscal policy.It may appear counter-intuitive at first, but the US economy did this four years ago. It eased the monetary policy and backed that up by additional fiscal imprudence. The result? The US economy is now healthy, and getting healthier by the day, with forecasts of more than 3% growth in 2015.


The Indian scenario looks tough with a tight monetary policy. That combined with little or no investments and high savings is not the recipe for economic revival. Economic growth is led by investment, labour productivity, capital and consumption. Combined these generate a higher gross domestic product (GDP) growth. With the needle of consumption stuck where it is, it is capital that now needs to be directed into major investments. Otherwise the true potential of India’s economic growth may not be realized. The government’s efforts to control its fiscal deficit by reducing expenditure could go in vain. In fact, a slowing economy can lead to a slide in government’s revenues. This could increase the fiscal deficit, which it is trying to control. It is investment sentiment that the government needs to, and can, change. As big expenditures into infrastructure, roads and other areas are made, it can generate employment, create vibrancy in the economy, kick-start the payments cycle, boost earnings of companies, and turn around the cycle for the better.


The government’s fiscal targets may slip for one or two years. But, by just letting its purse loose, and pepping up the investment cycle, it will change the sentiment towards investing.


High fiscal deficit may not be bad and, in fact, may be the need of the hour when spending is of the right nature. Back in 2003, there was high fiscal deficit, but what followed was an economic expansion that took India’s growth rate to 7% and beyond. In 2009, the fiscal deficit took a knock again, but growth rebounded in the subsequent years.


Other countries emulated similar fiscal policies to put their economies back on track. The US economy has rebounded after a fiscal expansion. Cycles can turn if the sentiment turns.


India’s problems started two-and-a-half years ago when the government held back payments to conserve fiscal deficit. Once a crucial segment starts to delay the cycle, its repercussions are felt across the rest of the economy. Companies see longer debtor days. Entrepreneurs are not willing to do business as capital is stretched, and profitability reduces. This, in turn, affects businesses and their capacity to expand and do business. The tailwind impact is then felt on credit growth, as entrepreneurs turn risk-averse.


Fortunately, many external indicators are favourable. Commodity prices are at their nadir, particularly crude oil, which helps save foreign exchange. Inflation is low, which reduces pressure on wage growth. So, there’s a real opportunity for the government to set things right. India cannot afford to squander such an opportunity.


There’s a hitch though. The government has to make the right kind of expenditure. Populist measures to jumpstart growth have not had the desired impact in the past. Schemes such as National Rural Employment Guarantee Act have affected inflation but with little effect on economic growth. This leads to inflation as no productive assets are generated. If the government can create schemes through which employment is generated and simultaneously productive assets are created, that will give a boost to the economy.


India’s growth can be sustained with a check on crony capitalism and its resultant sleaze economy. In the earlier phases of economic recovery, growth is very high. High growth with a control on corruption leads to more investments. Some of this is seen in China. Its initial investment did not attract much crony capitalism and it was able to utilize capital investment for productive use. That led to good growth and it was able to control wages. It created a value proposition for those outsourcing from that country. Similarly, the India growth story can be sustainable. All the government needs to do is foster the right fiscal stimulus and control the under-hand economy.


With the right stimulus, the Indian economy can do wonders. Profitability of companies will increase, also utilization of capacities would spur the private sector to make capital investments. For the government, it will lead to higher tax revenues, and lower deficit. It’s a virtuous circle that can rev up the engines of growth. But only the government has the key to the ignition of growth.


This article was published on 20th January in Mint newspaper