Fiscal push or reforms: What should it be? Fine print holds clues

The Economic Survey states that growth is the single-most-important objective for India at this stage of development – a claim nobody will dispute. But how should India achieve this objective? Should the government follow an expansionary fiscal policy to boost growth – a demand-side push, or should the focus be on supply-side structural reforms? At first glance, the Survey argues for both, but a nuanced view suggests otherwise.

To be sure, the Survey paints an optimistic growth outlook. It expects mass vaccinations, supply-side reforms, a push on infrastructure, a boost to manufacturing due to the production-linked incentive scheme (PLIS), pent-up demand in services, easy monetary conditions, among other factors to lead to real GDP growth rebounding to 11% y-o-y in FY22, and argues that this is conservative. We agree. Alongside the expected upturn in the global trade cycle in the second half of 2021, we believe that India’s real GDP growth could surprise positively, by rising 13.5% in the next fiscal. As such, the trade-off between growth and fiscal consolidation may not be as stark as one imagines, because the economy will benefit from the tailwinds of higher nominal GDP growth (we expect close to 17% in FY22), which will boost tax buoyancy, and also due to an aggressive disinvestment agenda amid buoyant asset prices.

However, the reality, as the Survey argues, is that it will still take two years for the economy to revert back to the pre-pandemic level and the pickup in growth, or rather the economic normalisation we have seen thus far, is not yet sustainable. As such, when it comes to choosing between fiscal consolidation and supporting growth, the Survey calls for a more active countercyclical fiscal policy as a centrepiece for supporting growth in the foreseeable future. This requires a re-writing of India’s fiscal rules, to make them more counter-cyclical. Without growth, India cannot attain debt sustainability. Growth is also necessary for alleviating poverty and reducing inequality – two challenges thrown up in the aftermath of the pandemic.

Interestingly, even as the Survey argues for fiscal activism in the near term, this appears to be focused on the supply-side. It argues for increasing public investment centred on the National Infrastructure Pipeline. Infrastructure investment tends to have larger fiscal multipliers, and hence can crowd in private investment by boosting demand for machinery and other equipment. It reiterates the importance of the PLIS in making the Indian manufacturing sector more competitive, attract investments and enhance exports.

Importantly, and perhaps more so after the pandemic, it calls for increasing investment in health infrastructure, by boosting public spending from 1% of GDP currently to 2.5-3.0% of GDP, along with the setting up of a sectoral regulator in light of the market failures due to information asymmetry. However, achieving these objectives requires a certain ecosystem. For instance, the Indian manufacturing sector cannot get integrated with global value chains purely based on fiscal incentives; it needs to be competitive. Infrastructure investment is important, but how do we address the execution bottlenecks they often encounter? In this regard, the Survey rightfully focuses on the need for process reforms and innovation to boost India’s competitiveness.

Overregulation has led to opaque supervision, and India should move in the direction of simple regulations combined with transparent decision-making process. We would argue that India should construct a sectoral regulatory scorecard comparing its regulations for same industries and consumer products across developed and developing countries on key parameters – such as the length of regulations, simplicity of compliance, cost of compliance, time required to comply – and start winning on each of these.

Also, India needs to significantly accelerate its investment in R&D to become more innovative. The Survey states that the share of private sector participation in gross R&D expenditure is significantly less than the top 10 economies, and that this is not due to the lack of tax incentives. This is a surprising result, although one cannot dispute the need for greater R&D investment that is geared towards boosting productivity.

Finally, the ability of the financial sector to support growth in the coming years is crucial. On this, the Survey steers clear of any discussion on the bad bank proposal, but instead argues that prolonged forbearance after the global financial crisis engendered the recent banking crisis, hurting investment and economic growth. As such, the forbearance measures announced after the pandemic need to be for emergency use only, and should be reversed when the recovery sets in. Additionally, the Asset Quality Review should mandate capital raising for banks, so that the banking sector does not become a hindrance to growth.

On the whole, while the Economic Survey bats for both fiscal stimulus and reform stimulus, in the end, both appear to be aimed at boosting the supply-side of the economy.

(The writer is Chief India Economist, Nomura. Views expressed are personal.)