The Twin Engines of Revival

EVER SINCE THE first Atmanirbhar Bharat package was launched in May, dreary commentary and dire prognosis have followed the announcements. Critics have been quick to point out that while the packages look impressive on paper, the Government has shied away from spending what they think is necessary for economic revival. Comparisons are made to the stimulus package implemented in the wake of the global financial crisis in 2008. So it was not surprising that the third such package, announced last week, met with the same scepticism.

However, instead of sinking in the absence of ‘large spending’, India seems to be responding well to the allegedly homeopathic economic medicine administered by the Narendra Modi Government. As in the past, some excuse is always available. This time, it is the festival season that is seen as the reason for the ‘temporary’ blip in India’s economic fortunes. Never mind that before the festival season, ‘unlit lamps’ was the refrain. The Government, however, has continued with its programme. In the third economic package, a slew of measures for real estate, production-linked incentives for key sectors, encouragement to companies to hire more and clearing off the pending subsidy of the fertiliser sector were announced by Finance Minister Nirmala Sitharaman on November 12th.

In absolute terms, the outgo from the Government’s coffers will be low, as has been the case with all Atmanirbhar packages. There has been constant criticism ever since the May 12th package was announced. The reluctance to spend more should be seen against the backdrop of the changing nature of risks in the last six months. These packages differed substantially from what fiscal stimuli are ordinarily understood to be. In common terms, a fiscal stimulus is usually expenditure undertaken by a government to give a boost to the economy. This can also be a reduction in taxes so that firms and individuals have more money in their hands for spending. The Modi Government could not do this back in May as its revenues had collapsed. In April, Goods and Services Tax (GST) collections stood at Rs 32,172 crore as compared to Rs 1,13,865 crore in April last year, a decline of nearly 72 per cent. May was only slightly better. In those months, no one could say anything about the duration and the extent of the pandemic. Not spending to revive the economy made sense for an additional reason: India had enforced what was one of the most thoroughgoing lockdowns anywhere in the world. Mobility came to a halt in May and was not restored until late June. The immediate need was to provide succour to the more than three million migrants who had returned to their villages in northern and eastern India from the industrial hubs in western and southern India. The criticism sounded appealing at that time: it was now or never for the Indian economy. Except, it was not.

In mid-June, the nature of risks changed dramatically. The death of 20 Indian soldiers in the Galwan Valley shifted the risk from domestic uncertainty to external threat. Even the most sophisticated analysis and modelling cannot predict the extent and end of a raging pandemic and the probability of war. Either way, this was a situation of extreme uncertainty in which the Government could not give preference to spending for economic revival instead of preserving money in case of unforeseen situations and challenges arising from the Chinese threat or further waves of Covid-19 infections.

Then, sometime in October, officials began hinting that the Government was not averse to spending more to stimulate the economy, a demand that economists had been making since May. In late October, the Government revoked the spending curbs it had imposed on April 8th because the ‘cash position of the government may be stressed in Q1 of 2020-21.’ By then, many things had begun falling in place that allowed a re-evaluation of spending possibilities and priorities. For one, GST collections picked up smartly from June. But the Government seems to have gained confidence in the sustainability of these collections only from September, when they crossed the Rs 95,000 crore mark—higher than the corresponding period in 2019. The same trend was witnessed in October when the psychologically important Rs 1 lakh crore barrier was breached. The collections were, again, higher than the same month last year. Over and above this, a number of high frequency indicators, such as the Purchasing Managers’ Index (PMI), showed expansion that had not been seen for a very long time. A number of other indicators, such as a healthy increase in railway freight—based on iron ore exports, coal and foodgrains—picked up from July. This indicated a recovery in economic activity from the lows of April and May. By November, the most pessimistic private sector forecasts began being revised again. To give one example, the investment bank Goldman Sachs had estimated India’s growth contraction in 2020-2021 at 14.8 per cent in September, a figure that was revised to a contraction of 10.3 per cent. It estimates a rebound of 13 per cent in growth in 2021-2022.

‘A pivotal assumption for our 2021 India growth outlook is broad-based availability of an effective vaccine, which could allow containment policies and mobility to normalize fully by mid-2022,’ Goldman Sachs economists Jonathan Sequeira and Andrew Tilton declared in a report.

THESE POSITIVE CHANGES are held to be the reason behind the Government’s willingness to contemplate higher spending and loosening of its purse strings. But there is one big, unstated, factor at work that has changed spending calculations.

At the end of August, the Indian Army launched a surprise operation and secured the Kailash Range of mountains on the southern side of the Pangong Tso Lake in eastern Ladakh. The operation caught the Chinese People’s Liberation Army (PLA) by surprise. Military observers hinted that a Chinese reaction was likely “sooner than later” to regain the military initiative in that area. Given the elevation and topography of the area, such an operation was more likely before the snow set in. Snow on the high ranges and passes makes such actions very difficult. From this perspective, September was a critical month when a Chinese reaction was likely. By then India had begun hectic diplomatic efforts to contain the Chinese threat. Yet, with an aspiring hegemon like China, diplomacy is weak medicine and India had to be prepared for a military offensive. But as October passed, the chances of a Chinese offensive dimmed considerably. This situation is likely to remain unchanged for the next three to four months while eastern Ladakh remains snowbound.

Had India’s hand been forced and the country compelled to take military action to counter Chinese aggression through defensive operations, the costs incurred would have been extremely heavy to the point of being catastrophic for the Indian economy. In such a situation, undertaking an economic stimulus would have been foolhardy. Costs of war are very hard to estimate and extrapolations from past conflicts are almost useless. For example, it has been estimated that the 1971 war with Pakistan cost India Rs 200 crore per week. This has been extrapolated to the present on the basis of inflation and increases in material costs and estimated to be Rs 2,000 crore per week. With China, a far more powerful adversary, these costs are certain to be much higher for a variety of reasons. Over and above these operational costs of running a war, the damage to the Indian economy would be very hard to estimate. For one, the marshalling of resources for the war effort would bring normal economic activity to a halt. For another, foreign investments—both direct investment and portfolio investment—would reverse. An economic collapse would not be beyond the realm of the imagination. This was in all likelihood a determining factor for the Government’s reluctance to launch a stimulus programme.

Now that the Chinese threat has receded, for the time being, can the Government afford higher spending? Writing for Open in August, economist Sajjid Z Chinoy explained India’s slowing economy and its dependence on public spending (‘Growth in the Time of Corona’). He wrote: ‘India therefore entered Covid with both private consumption and investment slowing. Instead, GDP growth was largely held up by government spending, which grew twice as strongly as the private sector since 2017 and almost four times as strongly in the pre-Covid year.’ The result was that when the pandemic hit India, the Government was already spending a very high amount and it is certain that India’s fiscal deficit will be significantly higher than the budgeted figure of 3.5 per cent of GDP for 2020-2021. In 2019-2020, the situation was so dire that the Public Sector Borrowing Requirement (PSBR)—a more expansive definition of government’s borrowing requirements than what is suggested by fiscal deficit—stood at 8-9 per cent of GDP, fully exhausting household savings of around 7.2 per cent of GDP. The Government was clearly living beyond its means.

This may have changed now. Preliminary estimates by the Reserve Bank of India (RBI)—released in its November bulletin—show that household savings in the first quarter of 2020-2021 stand at a whopping 21.4 per cent of GDP. This is higher than the annual household savings in 2018-2019 (7.2 per cent of GDP) and 2019-2020 (8.3 per cent of GDP). The RBI noted that private consumption declined by 26.7 per cent (year-on-year) during the first quarter of 2020-2021 due to the lockdown, thus increasing savings. People simply did not have the opportunity to spend as only essential services and goods were available and the options for discretionary spending were extremely limited. Another reason for this trend is likely to be ‘precautionary savings’, as people worry about their jobs and future income along with the possibility of much higher medical expenses that may become necessary due to the pandemic.

The result is that the pandemic has had an unexpected but happy effect: the Government now has the resources necessary to ‘spend its way’ out of the economic morass. To use political phraseology, there is now a ‘double engine’ of reviving economic activities leading to a healthy inflow of indirect taxes and much higher household savings. It can, if it wishes, undertake expenditures that were unthinkable even six months ago.

The political economy of government spending in India before 2014 had one marked feature: leaky spending on ‘welfare schemes’ for the poor. The poor did get something but, along the way, large sums were siphoned off by corrupt intermediaries. Under the Modi Government, spending for the poor has continued as before but in a much more tightly managed manner to prevent leakage and corruption. Emergency help programmes, such as the Pradhan Mantri Garib Kalyan Yojana, managed to get relief aid to migrants and other people in distress in a relatively clean manner. Predictably, this has not gone down well in certain quarters where it has been dubbed as a fetish for small schemes. The idea that the government should borrow more and spend liberally during a crisis has impeccable Keynesian roots. But in India, the danger of ‘Keynesianism for the corrupt’ is ever present and under Modi one of the priorities has been to prevent this politically damaging outcome. This has been cited as an example of a ‘conservative government’ unwilling to spend. If anything, fiscal deficits have remained high in the past years. The overriding concern has been how to spend for the poor without letting corruption and cronyism set in.

There is little doubt that India has been hit hard by the pandemic. It is unlikely that the country will return to a high growth path before 2022. Along the path, there are plenty of imponderables and the same structural features that have held back the country. To cite another example, the RBI has flagged the danger of high inflation rearing its head again. In the last two months, retail and wholesale inflation has returned. But unlike past bouts of high inflation, this is due to broken supply chains, labour shortages—and higher wages demanded by available labour—and other ravages of the pandemic. This calls for a different remedy than restricting money supply and tightening interest rates. Call it a fortuitous event or a thought-out response, the RBI did the heavy lifting in the earlier rounds of the Atmanirbhar packages in providing a credit lifeline. Chance, it seems, has favoured India, so far.

economic revivalGDP growthGSTIndian economyNirmala Sitharaman