Sunday, September 20, 2015

The problems with a public investment-led growth strategy for India

Srinivas Thiruvadanthai makes a good case for a public spending driven economic growth restoration strategy for India. I agree with the broader thrust, though I am not persuaded that many of the assumptions will hold as readily as envisaged. Consider the following,

1. The assumption that the rising corporate free-cash flows would lead to investment spending once the public spending kicks-off may not prove right. What if the free-cash flow is being used to deleverage, as is the case in many sectors? Does the government have the requisite fiscal fire-power (in size and time) that would enable the deleveraging to play out enough to ignite the investment cycle? Even assuming this fiscal space is available, is it just a deleveraging problem or are there other factors involved? What if many of the corporate investments are simply commercially unviable and insolvent (it would not be a stretch to assume that a large proportion of the infra projects are simply insolvent, and in some like steel, significant parts of the sector itself may be under water)? By itself, market is unlikely to force such projects/corporates to liquidate. We may need more aggressive actions by creditors, which in turn runs into institutional challenges like bankruptcy code etc?

2. The assumption about current account deficit moderating may not play out. It may be that oil stays low for some time, but gold, especially with the return to normalcy in US (and potential uptick in inflation), may start to recover, though not to the same previous levels. In any case, the last four months, gold imports have been rising. And once public investment cycle starts, the imports of equipments (even mineral ore commodities etc) etc will rise forcing up the imports. And, with no prospect of exports rising, the pressure on CAD may not be as benign as is being thought of. 

3. The assumption about inflation remaining under control too may not be correct. From everything we have seen, the Indian economy simply does not have the capacity to sustain very high growth rates for more than 3-4 years. From cement to pulses, once the supply and demand side expands, constraints will start to bind, driving up inflationary pressures. This is a constant theme in the speeches of the RBI Governor himself. 

4. Finally, the flow Vs stock juxtaposition of the public debt, while logically unexceptionable, may be less so in the real world. Given the impending return to normalcy in US credit markets, the continuing global economic weakness and uncertainty in the global financial markets which are unlikely to disappear anytime soon, the professed desire of India to attract patient foreign capital in infrastructure, and its recent history of macroeconomic imbalances, the global credit markets (rightly or wrongly, a fact beyond anyone's control) may not view a return to higher fiscal and current account deficits as good signal. And we all know that these things impose significant costs on open economies, however good the fundamentals, once the volatility strikes and sudden stop ensues. As to our comfortable debt stock, the high inflation has undoubtedly been the key player in keeping it low. Now that inflation is low, the trajectory of the stock remains to be seen.

However, having said this in provocation, public spending in infrastructure should go up considerably, even at the risk of slightly bumping up the twin deficits. In its absence, with exports not an option, corporate balance sheets weak, banks under stress, and household spending not broad-based enough, there is simply no engine to restore growth and the economy may remain entrapped in the gridlock for long enough to do irreparable damage.

A more broader case to be cautious about a public investment led growth strategy is made out in an earlier post here


Unknown said...

You have made good points. A combination of public investment, consumption growth, internal restructuring coupled with governance improvements by corporations are needed to revive animal spirits in the private sector.

Public Investment may not be able to revive all corporate zombies. Perhaps, not all need to be or deserve to be revived. If, at the margin, it revives cashflows for some of them who may be involved in public infrastructure investment, then the multiplier effect might take over from there. We are talking about igniting and not taking over the growth process by the government.

Your points about India's inflation penchant, the tendency for current account deficit are well made and noted.

That is why there has to be a grand bargain with the corporate sector. Ad-hoc tax exemptions should be phased out, bankruptcy enforced and defaults criminalised severely without any personal favours or forbearance.

These should have the effect of boosting governance and productivity in the corporate sector. It may not immediately eliminate the tendency for overheating in the Indian economy. Again, it will change things at the margin, it might catch on and lead to other better things.

The real issue with growth is the extremely fragmented nature of India's farm and factories. As long as that is the case, there is not much hope for sustained high growth in India. That is my personal view. But, that is another topic for another occasion.

Gulzar Natarajan said...

Thanks Ananth for the great points...

I agree that the point of public investment being about "igniting" growth. We can only hope that the trigger, if applied quickly and in sufficient size, will be adequate to revive the investment cycle..