India needs fiscal push to boost growth, but rise in public spending may take time

It is no secret that India is in the midst of an economic slowdown, as domestic demand has weakened, rural as well as urban consumption is on the decline, exports are on a weak wicket and public investments have been declining. Most economists agree that the GDP growth slowed in the second half of FY2019 compared to the first half and going forward, growth in 2019-2020 is also expected to be lower. An analysis by the State Bank of India has pegged GDP growth in the March quarter at 6.1% versus 6.9% for the full fiscal 2019.

Now, as the second term of the Modi government starts, there are expectations of a fiscal stimulus to boost growth. Put simply, this means people expect the government to step up spending in a big way – build more roads, invest more in other infrastructure, cut taxes and reduce interest rates. A fiscal stimulus package may seem like the perfect panacea but may be easier said than done, given India’s fiscal constraints and historical data suggesting that central government expenditure typically slows in the year following general elections.

Saion Mukherjee and Neelotpal of brokerage Nomura pointed out that quarterly results of India Inc thus far indicate an all-round slowdown in consumption. The impact of the slowdown on earnings is strong, particularly on discretionary consumption, with a significant contraction in EBITDA (Earnings Before Interest Tax Depreciation and Amortization) margins of India Inc. The analysts also said that there was limited space for a fiscal stimulus.

“We highlight that the government’s fiscal position is stretched, given the risk to revenue collection in the backdrop of a slowing economy. Any further significant rise in off-budget expenses on infrastructure and regular slippage on the fiscal front by the state governments would present a challenge. Historical data on government expenditure growth suggests that central government expenditure growth slows in the year following a general election. The FY20 interim budget suggests that central expenditure growth levels will be maintained,” Mukherjee and Sahu said.

Why are Indians postponing discretionary consumption?  The factors at play include a) a slower rise in government employee salaries after the hikes related to the Pay Commission b) the lagged impact of rising fuel prices (Mukherjee and Sahu point to a three-quarter lag correlation between oil prices and real revenue growth of companies catering to discretionary consumption) c) a slowdown in consumer financing due to the NBFC crisis; d) the second level impact of a slowdown in investment growth on consumption – the rate of execution of projects has recorded a slowdown over the past three quarters.

In Modi government’s fist tenure, urban consumption had been given a boost through increased government employee wages over the past three years. The central government implemented the Seventh Pay Commission report in June 2016. In addition, the states started paying the benefits over FY17-FY18 and wages of government employees and public sector undertaking (PSU) employees increased by almost 60% between FY16 and FY18. The rise in wages is likely to slow from FY19. For central government employees, wages are likely to slow further in FY20.

The difficulty that the Nomura analysts have seen in government providing any fresh fiscal stimulus has also been voiced by analysts from IDFC. “There is very little room for the government to step up spending in any meaningful manner in the immediate future ahead. In fact in the interest of credibility it would be prudent for the government to restate the fiscal deficit taking into account the actual revenue outcomes for this year and the substantial usage of below the line items in financing the budget … some avenue for extra spending may come about if the government gets a significant transfer of capital from RBI. The government may also focus on more substantial monetisation of its assets in order to increase spending without appreciably breaching a fiscal consolidation framework. Ultimately, however, true fiscal flexibility will have to wait till recent tax reforms bear fruits respecting the so-called ‘J’ curve, especially in the case of GST,” the IDFC analysts said.

Sanjeev Prasad, Sunita Baldawa and Anindya Bhowmick of Kotak Institutional Equities have suggested a “directed fiscal stimulus (housing, for example)” to derive maximum gains from any limited fiscal stimulus as there is limited scope for broad fiscal stimulus. India suffers from (a) high and persistent fiscal deficit (b) faltering tax revenues (c) broken business models in agriculture and infrastructure. The three analysts have also spoken about a broad monetary stimulus in the form of rate cuts from the RBI and widespread but difficult economic reforms.

SBI has also sought rate cuts from the RBI, with chief economist Soumya Kanti Ghosh saying “we are penciling in a larger rate cut (35 to 50 bps) by the RBI in the forthcoming policy.” Ghosh has also suggested a CRR cut, saying a 1 per cent reduction in CRR could release Rs 1.28 lakh crore and reduce lending rates by 15bps.

Meanwhile the Federation of Indian Chambers of Commerce and Industry (FICCI) has suggested that the government should expand the direct income scheme for farmers to provide more money in the hands of rural consumers and thus boost rural discretionary spends. It has also sought various measures to boost exports, catalyse domestic demand – basically a comprehensive fiscal stimulus package. But given the fiscal constraints, one wonders if these demands can be met in the near term.