Fiscal stimulus imminent: What options do PM Modi, Jaitley have to revive the economy?

Finally, there's alignment of views within the government and outside that the Indian economy is not in the best shape. It took a nudge and a warning from BJP's parent RSS with some grounds-up feedback for the government to exit the denial mode and get into serious thinking on how to revive the economy.

The options are limited: India needs a fiscal stimulus urgently.

There are three golden Ts of a fiscal stimulus:

It must be TIMELY (with GDP growth of just 5.7 pc last quarter, perhaps, it's time to go for it).

It has to be TEMPORARY with a definite timeline and a wind-down (else it takes a heavy toll on the government's own balance sheet).

It should be TARGETED, else we could spray our resources thin without achieving the objective.

Normally, when governments need to revive economic growth, the broad objective must be to reinvigorate four major elements of the economy: Capital, Labour, Entrepreneurship and Land/Farming. When Barack Obama went for a stimulus under the American Recovery and Reinvestment Act of 2009, he spent over $860 million nearly equally on three areas: tax cuts; unemployment benefits and federal contracts. We do not have the luxury of time or the resources to do all of that at once. That's what Budget 2018 must aim at.

Instead, India immediately needs a fiscal stimulus. May be, even short bursts of 1-2-3 stimuli. But what should be the target? Besides growth, the aim must be to generate employment. Should the government aim at consumption-led growth or investment-led growth?

Since consumption is extremely sluggish in most sectors except a handful (auto, FMCG, durables, pharma), government can aid consumption by cutting taxes, making goods and services cheaper and hope that the consumer starts buying goods and services. That is unlikely. There is a crisis of confidence in the economy and in an atmosphere of uncertainty spending is the last thing on the consumer's mind. Any attempt to trigger economic growth via tax cuts would be counter-productive because not only will it leave a hole in the government's tax revenues but it will most certainly fail to prod the consumer to buy more.

Some argue that the stimulus must be aimed at the SME sector (over one-third of our economy) and the informal sector because those parts of the economy are in grave danger. That would be a futile exercise because the informal sector derived its 'competitiveness' from tax evasion/avoidance. No economy should create havens for such businesses.

SMEs are in trouble for a couple of reasons: one, the tier I or original equipment manufacturers they supply to are not doing well, hence, SMEs are also under-utilising capacities; two, exporting SMEs have been badly hit by the strengthening of the Rupee against the dollar. No government measure can help these directly.

Remember, Budget 2017 has already reduced corporate tax rate for SMEs up to Rs 50 crore in revenues by 5 pc to 25 pc and presumptive tax on businesses with revenues up to Rs 2 crore was reduced from 8 pc to 6 pc. Any more reduction in tax rate would create an imbalance where larger Rs 150-200 crore companies may start splitting to avail of the lower tax rate.

The other option is investment-led growth-or the Chinese model of growth.

Dr Surjit Bhalla points out in his column in the Indian Express that the real culprit is the RBI whose refusal to bring down interest rates fast enough is preventing private investments and hence bogging down economic growth. It is nobody's case that interest rates must not be reduced. It's the government that has been coy about persuading the banking system to pass on the entire repo rate cut to the borrowers.

However, at a time when the capacity utilisation across sectors hovers between 65 and 75 pc, don't expect private capex cycle to kick-start even if the interest rates are reduced substantially. Any industry needs to reach capacity utilisation of above 90 pc to start thinking of investing large amounts of capex in capacity addition. In fact, most industries are able to achieve production up to 105-110 pc by purely de-bottlenecking and manufacturing efficiencies. And capacity utilisation of that order may be some 2 years-or more--away.

Hence, by just deducting the options it's evident that consumption is yet to pick up across sectors; it can't be triggered substantially via tax cuts; SMEs already received a minor stimulus in Budget 2017 and it may not be possible to help them directly; interest rate cuts alone is not the answer; private sector neither has the appetite nor the inclination to invest in fresh capacities.

That leaves the only option for the TARGET: the government has to take it upon itself to trigger growth through investments over and above the ones announced in Budget 2017. They ought to span infrastructure (roads, rail and rural infrastructure), healthcare, education, low cost housing, digital India, etc. We could order new airports or modernise smaller airports (a plan that's been pending a decade). We could rebuild the water supply and drainage systems of large cities such as Mumbai. We could accelerate start river linking, river dredging projects. And we could allocate more and quicken the pace of smart cities projects. There are plenty of options available.

Investments in these have the potential to catalyse these sectors but allied sectors as well which could have a ripple effect on fresh employment generation. The reason why all discussions on economic growth boil down to infrastructure and real estate is because of the number of allied industries that benefit from it (cement, steel, aluminium, glass, paints, wires, switches, tiles constitute just a few of the 25-odd industries that directly benefit from infrastructure investments)

Not to mention that they will indirectly bring greater business for the SMEs who will be contractors and suppliers to such industries.

Financially, the government does not have the leeway just yet. Given that the government's income is not rising fast enough to fund these out of its own earnings, it may be forced to borrow or print fresh currency which will widen the fiscal deficit and trigger inflation. More importantly, it will take India a year or two away from meeting the fiscal responsibility targets. But as long as this isn't a prolonged stimulus but is rather given in bursts, that would be a reasonable price to pay in the short term. Remember, the stimulus must be temporary.

Perhaps, it has to be combination of fiscal stimulus through investment-led growth and monetary policy stimulus through interest rate cuts. May be a burst at a time.