New fiscal mindset key to reviving growth

Recycling assets - selling brownfield projects and investing the proceeds in greenfield projects - is India's best bet for growth revival

India's growth has hit a soft patch, battling structural, cyclical, domestic and global headwinds, all at once. It started with the fallout in the non-banking financial companies (NBFC) sector. While bank credit growth has picked up since, NBFC credit is slowing. And to the extent NBFCs were buoying growth in the fastest growing sectors, overall economic growth is at risk. 

The global environment is not helping either. India is more open and more affected by global issues than many believe. India's exports have been sluggish, and the complex set of issues dragging global growth lower are likely to impact India further.

India's potential growth (defined as the maximum growth possible without stoking inflation), has fallen from 8 per cent a decade ago to 7 per cent now. There are three main drivers of growth — capital, labour and total factor productivity (TFP). Recent reforms such as digitisation and the goods and services tax (GST) have focused primarily on raising TFP. In order to raise growth from here, capital and labour cannot be ignored. 

To be fair, growth could inch up in the second half of 2019 with election-related uncertainties fading, and the Reserve Bank of India (RBI) easing rates. But that can only take growth closer to 7 per cent, from sub-6 per cent in the quarter ending March 2019. Anything higher will need reforms which augment capital and labour. 

A fiscal and monetary policy trade-off

With growth slowing, there are big demands on the upcoming Budget (on July 5) as well as the next few Monetary Policy Committee (MPC) meetings. 

There is a sense that the cost of capital in India is very high. The simple solution is to cut the repo rate. The RBI has already cut rates by 75 bps in 2019, and based on their preferred range for real rates, there could be a maximum of 75 bps more in rate cuts. 

But repo rate cuts is just one part of the cost of capital. The other part is transmission of repo rate cuts. To get a better handle, we divide the cost of capital into three parts: One, the repo rate; two, the spread between the repo and the G-Sec rate; and three, the spread between the G-Sec and the corporate bond yield. The G-Sec spread and the corporate bond spread remain elevated. 

The former is a consequence of high public sector borrowings. Elevated and sticky, they are exhausting the market. The timing is not desirable either. Borrowings have been rising around the time net household financial savings have fallen. The "investible surplus" available for private investment has shrunk meaningfully. 

The bottom line is clear: While there is some space for monetary easing, there is no space for a higher fiscal deficit and higher borrowings.  

A call for adopting an ‘asset recycling’ mindset

And yet, there is scope for imparting a positive fiscal stimulus to growth, without endangering the fiscal deficit target. The way out is the idea of "asset recycling". This is not a new idea. Like many other reform ideas, it has been incubating over the last few years, and we think its time has come. 

This idea includes disinvesting government stakes in companies, but is not just limited to that. This idea includes the selling/auctioning of several kinds of government owned assets such as roads, ports, airports etc. The proceeds from these sales can be used for the creation of new assets — new roads, new ports etc — which can be recycled again, when completed. As such, the same pot of money is recycled several times over, without endangering the fiscal deficit, and yet upgrading India's infrastructure.  

Who would the buyers of the recycled assets be? Many long-term investors, foreign and domestic, such as pension funds and insurance companies may be interested in this. Several investors are averse to construction risk (for instance, building a road), but do not mind the operating risk (for instance, tolling and maintaining the road).

Is this a public-private partnership? Not in its original form where the government and the private sector joined hands to construct. Here the government constructs and sells off to the private sector thereafter.

How large could the growth impact be? Our calculations show that at the promised 3.4 per cent of the GDP, the central government fiscal deficit for FY20, the growth impulse is zero. If, say, assets worth an additional 1 per cent of GDP are recycled this year, assuming a capital expenditure multiplier of 1, growth could rise by 1 percentage point. 

India’s chance for an investment led recovery

As mentioned earlier, India's growth revival must come from augmenting capital and labour. Labour reforms are essential, but complex. The growth pay off will only trickle in gradually. 

Investment revival can be a tad faster. And given a high fiscal multiplier for public capex, it can "crowd in" private capex over time, if done in a fiscally responsible way. 

  

India's best bet to raise growth is by reviving the investment cycle. India's best bet to raise private investment (which makes up 75 per cent of all investment) is by creating a conducive environment, by stepping up public investment in a fiscally responsible way. And that can only happen by adopting “asset recycling”. 
 

The author is chief India economist, HSBC Securities & Capital Markets (India) Pvt Ltd