Wednesday, January 28, 2015

Why a public investments led strategy may not work?

Commentators from both the right and left have converged to the view that the Indian economy needs a large dose of public investment in infrastructure to provide the impetus to regain high economic growth rates. But there are atleast seven reasons to be sceptical of this strategy.

1. A first order reality is that neither the central nor state governments have the fiscal space to prime the pump in any significant manner. Also, unlike the developed economies, interest rates in India are not anywhere near the zero-bound to make capital expenditure borrowings a high-return strategy.

2. Public investments become effective in stimulating the economy only when they can be kick-started without delay. However, given the long time lag between identification of project and the first stone being laid, and the poor track record of in-time completion of public investments, the efficacy of public investments in providing the immediate thrust for regaining high growth rates appears questionable.

3. Even assuming a readily available shelf of "shovel-ready" projects, they can take off only when developers and banks have adequate space on their balance sheets to take on more projects. Given the debt-laden balance sheets of infrastructure firms and the high proportion of distressed assets of banks, the prospect of neither look promising.

4. If the objective is regaining the near double-digit growth rates, then public investments will not be able to achieve that without other critical enablers. Apart from the success of initiatives to improve business environment and stimulate manufacturing, the country can sustain high growth rates only if it is able to sharply increase its savings rate. Further, if the savings rate increases to the 35-40% of GDP range, then the desired level of public investments are in any case most likely to follow.

5. The argument that we only have a flow problem (high fiscal deficits) and no stock problem (lower debt-to-GDP ratio) is misleading. Our debt-to-GDP ratio has been held in the 60-65% range only by the long period of high inflation, which has helped the country inflate away its debt. If the inflation gets anchored at a lower rate, as looks likely, then the stock problem will start to assume significance.

6. The country has struggled hard to restore some macroeconomic stability by reining in revenue expenditure and tight monetary policy. A quick return to high fiscal deficits would certainly erode the hard-won and costly policy credibility. This assumes great significance in a world where massive amounts of capital slosh around and economies are deeply vulnerable to sudden-stops and flow reversals.

7. Finally, all this works on the premiss that we need to do everything possible to regain the high growth rates of the 2003-08 period and emulate China's spectacular three decade long near double-digit growth trajectory. But what if this premiss is itself questionable. Given the prevailing domestic macroeconomic and socio-economic environments and global trends, there are compelling reasons to argue that it may not be possible for India to sustain high growth rates for any long duration.

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