The Chinese State Council, its Cabinet, announced a massive fiscal stimulus of $586 billion (roughly 7% of GDP) over the next two years to construct new railways, subways and airports and to rebuild communities devastated by an earthquake in the southwest in May.
The global economic meltdown is weakening the Chinese economy as growth in exports and investment is slowing, consumer confidence is waning and stock and property markets are severely depressed. China needs to sustain the high growth rates to sustain the massive rural to urban migration that has under grid its double digit growth of recent years. It is also necessary to prevent mass lay offs that are inevitable due to the massive over capacity that has been built up across the manufacturing sector.
In China, much of the capital for infrastructure improvements comes not from central and local governments but from state banks and state-owned companies that are encouraged to expand more rapidly. Accordingly, the State Council said it was loosening credit and encouraging state-owned banks to lend as part of a more "proactive fiscal policy".
Further, unlike the Western economies, the Chinese government exercises considerable control over private sector investments too and can play a significant role in channelizing them to priority sectors. In fact, state-driven investment projects of this kind have been a major impetus to the impressive Chinese growth throughout the 30 years of market-oriented reforms. The biggest players in many major Chinese industries — like steel, automobiles and energy — are state-owned companies, and government officials locally and nationally have a hand in deciding how much bank lending is steered to those sectors.
The government said the stimulus would cover 10 areas, including low-income housing, electricity, water, rural infrastructure and projects aimed at environmental protection and technological innovation — all of which could incite consumer spending and bolster the economy.
Unlike China with its current account surplus, $2 trillion forex surplus, and balanced budgets, India suffers from soaring deficits in current account and on the fiscal front. The off-balance sheet items of oil and fertilizer bonds, farm loan waivers, etc stretches the fiscal deficit to unsustainable levels. The finances of the state governments are in even worse shape and with elections around the corner, they are likely to cut back on important long term infrastructure investment support in favor of populist individual welfare benefits.
In the circumstances, the federal government has very little cushion to indulge in significant fiscal pump priming or assisting the state governments. One of the options would be to take a leaf out of the Chinese book by incentivizing the banking sector, over which government continues to exert considerable influence, to lend to the infrastructure sector.
In any case, given the ongoing economic slowdown, banks too would have limited lending opportunities. Further, unlike the US, the financial markets in India are facing a liquidity as opposed to a solvency crisis, with apprehensions about counter party risks clearly coming in the way of regular commercial lending. Infrastructure presents one of the most attractive commercial lending opportunities, especially with its long gestation periods (this assumes significance since the slowdown is most certainly going to be a temporary one). With infrastructure providers dependent on bank lending for their massive portfolio of project proposals, and bankers sitting on an enhanced pile of cash, there is a reasonably good fit between the borrowers and lenders.
Another option would be to set up a form of Sovereign Wealth Fund (SWF) or a Special Investment Vehicle (SIV) that could channelize the $250 bn plus forex surplus into more productive investment avenues rather than in low return investments. For example, the SIV can finance infrastructure investors' import requirements of capital equipments.
Such alternatives will enable the government to keep the investment tap open and effectively pump prime the economy, without any adverse fiscal consequences.
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