What will it take to sustain the recovery?

A return to a high growth path will not happen on account of market forces alone.

Four factors will have a crucial bearing on India’s growth prospects and determine macroeconomic policy in the near future.

First, the strength of the ongoing recovery. Secondly, the potential for disruption in the latest strain of the coronavirus, Omicron. Thirdly, the size of the fiscal deficit in FY 2021-22. Fourthly, the appointment of Jerome Powell to a second term as the chairman of the US Federal Reserve.

India’s gross domestic product (GDP) growth of 8.4 per cent in the second quarter of the current year is broadly in line with expectations.  On this basis, the economy should meet the Reserve Bank of India’s (RBI’s) forecast of 9.5 per cent growth for the year and, perhaps, even exceed it.

However, the emergence of a new variant of coronavirus, is a complication. The expert view —and one invokes experts with some hesitation in relation to the coronavirus — seems to be that the current variant is not very lethal. Nevertheless, fear of the virus and the isolation it requires is pervasive. It is likely to adversely impact the incipient recovery in the contact-intensive services sectors. Even in other sectors, firms are wary of getting employees back into offices even where work from home is sub-optimal. 

The fiscal picture is not comforting either. The rise in indirect tax collections gave room for optimism. This has been offset by the negative news on the expenditure front. The privatisation target is likely to be missed. The government will be relieved if it can stick to the fiscal deficit target of 6.8 per cent of GDP in the current year. 

Lastly, we have the nomination of Jerome Powell for a second term as chairman of the US Federal Reserve. Mr Powell has been more sanguine about inflation in the US than many distinguished economists. He has changed his position slightly in recent weeks. However, this change is only to the extent of bringing quantitative easing to an end earlier than planned. Mr Powell is in no hurry to raise interest rates. 

What does this combination of factors mean for policy-making in India? If the experts are right about the Omicron variant, it will result in some loss of momentum but will not derail growth in the current year.  Emerging markets need not fear any immediate flight of funds and their own central banks will not be under pressure to raise interest rates. The prospect of the RBI raising interest rates in the next few quarters is low. The growth outlook for the current year remains good.  

Illustration: Binay Sinha

It is the outlook thereafter that is somewhat murky. There is a question mark over three key drivers of growth, namely, private consumption, exports and private investment.  

Private consumption has been adversely impacted by the massive job losses on account of the pandemic and the fear factor. As the RBI governor noted recently, both private consumption and investment remain below their pre-Covid level. 

Any jubilation over the surge in exports in the first half of the current year is misplaced. Between 2014 and 2019, exports were virtually stagnant— the figures were $314 billion and $320 billion, respectively. Exports fell to $296 billion in 2021. If we reach the forecast level of around $400 billion in exports in FY22, it would amount to a compound annual growth rate of just 3 per cent. India’s share of world exports has remained at 1.7 per cent in recent years. It is hard to see exports propelling a return to 7 per cent growth.

As for private investment, for several quarters now, we have been hearing that a revival in investment is round the corner. It is yet to materialise. The cut in the corporate tax rate from 30 per cent to 22 per cent introduced in 2019 has not translated into any boom in private investment. There is an accretion to profits of corporates and this, along with efforts at deleveraging, has caused a steep fall in leverage among corporates. The debt to equity ratio of 1,360 non-financial private companies was a mere 0.20 in the second half of FY 20-21. (RBI Financial Stability Report, July 2021).

At this level of leverage, companies should be willing to borrow and invest and this should reflect in healthy credit growth at banks. It is not happening. True, aggregate capacity utilisation in Indian industry is quite low at the moment — 70 per cent. But corporates must know that this is a transitory phase caused by the pandemic. It cannot be that Indian businessmen are blind to long-term opportunities at a time when foreign direct investment is booming. 

Could it be that the reluctance to invest is on some other account? Businessmen may be averse to increasing leverage, given that the threat of losing control is very real now under the Insolvency and Bankruptcy Code. They may prefer to finance growth through equity rather than debt.  Banks are willing to lend to them but they seem reluctant to borrow. 

With small and medium enterprises (SMEs), it’s the other way around. They are willing to borrow but banks don’t want to lend to them. With corporations and SMEs unwilling or unable to invest, it is unrealistic to expect a quick revival in private investment. 

Whichever way you look at it, it does appear that public investment holds the key to an early return to a high growth path. How do we finance public investment at a high level given the budgetary constraints? A way out may be to borrow an idea mooted in the US recently, namely, to have the central bank fund a public infrastructure authority against quality collateral, say, AAA securities. This could be a way of augmenting funds for the ambitious National Infrastructure Pipeline. 

Central bank lending to a public authority has advantages over central bank lending to government (or monetisation of the deficit). Governments are seen as irresponsible spenders not subject to adequate market discipline. Central bank lending to a public authority would be against quality collateral, so the public authority would be subject to market discipline. Secondly, central bank lending to a public authority does not count as public debt. It goes without saying that such lending by the RBI would have to be consistent with the inflation targeting mandate.

On present evidence, it does not appear likely that a return to a high growth path will happen on account of market forces alone. A big push from public investment is required. Central bank funding of a public infrastructure authority may well be the answer.

(ttrammohan28@gmail.com)