Friday, February 10, 2023

Four trends that will impact the Indian economy


I identify four broad economic trends from which there is no escape for the Indian economy:

1. Government capital expenditure will drive the economy in the medium-term.

2. 2. High fiscal deficits are here to stay.

3. 3. Inflation will be higher than before

4. 4.  Self-reliance and import-substitution are a reality

The macroeconomic outcomes that we can realise will be constrained by these four trends.

More in my BS article, Four economic trends that will impact India.

Four economic trends that will impact India

There are four broad trends that will impact the Indian economy in the years to come. The Budget for 2023-24 affirms these trends.

1. Government capital expenditure will drive the economy in the medium-term: The latest Economic Survey underlines the fact that government capital expenditure has risen from a long-term average of 1.7 per cent of gross domestic product (GDP)in the period FY09 to FY20 to an estimated 2.9 per cent of GDP in FY23. The latest central Budget expects capex to rise to 3.3 per cent of GDP in FY24.


This points to an inconvenient fact: Private investment has remained sluggish and the government has had to compensate. The behaviour of private investment is not unique to India. It is part of a trend that is seen in emerging and developing economies (EMDEs). As the World Bank’s Global Economic Prospects (2023) points out, investment growth in EMDEs in 2022 remained about 5 percentage point below the 2000-21 average, and nearly 0.5 percentage point below in EMDEs excluding China. 


The World Bank does not see private investment returning to the level suggested by the pre-pandemic trend through 2024. It lists several factors responsible for the slowdown in investment growth in EMDEs: Slower output growth in 2010-19; lower commodity prices; lower and more volatile capital inflows to EMDEs; higher economic and geopolitical uncertainty; and a substantial build-up of public and private debt. Many of these factors apply to India.  


The government sees a sharp rise in capex in FY24 as boosting output growth. This overlooks the fact that the fiscal deficit is projected to decline by 0.5 per cent of GDP in FY24. We have a withdrawal of stimulus, something that is contractionary in nature. 


True, the composition of expenditure has shifted even more towards capex, and this is expansionary. But this effect can overwhelm the contractionary effect of a fiscal deficit decline only if the rise in capex is greater than the decline in the fiscal deficit.  In  the budgetary projections, the rise in capex is 40 basis points whereas the decline in the fiscal deficit is 50 basis points. The net effect will, therefore, be contractionary


2. High fiscal deficits are here to stay: Analysts cheered the finance minister for sticking to the fiscal deficit of 6.4 per cent for 2022-23, and projecting a fiscal deficit of 5.9 per cent for 2023-24. The figure for 2023-24 is a budget estimate. If the Ukraine conflict escalates and the global situation worsens, government subsidies (which have been pruned in FY 2023-24) will rise and we could be back to square one. We must also expect sops to be rolled out in the run-up to elections in 2024.  


The fiscal situation can be turned around in a fundamental way only if the tax-to-GDP ratio goes up significantly (say, above 12 per cent of GDP) or if capital receipts from disinvestment rise significantly or both. On either count, the outlook is not promising. The tax-to-GDP ratio   is estimated at 11.1 per cent for 2023-24.  The peak in the past decade has been 11.4 per cent.  


As for the proceeds from disinvestment, the Economic Survey notes that total proceeds from sale of equity in public sector units (PSUs) amounted to ~4 trillion in the eight-year period from 2015 to January 2023, or an average of ~50,000 crore in a year. Strategic sales have yielded a mere ~69,412 crore in the entire period. It does look as though the Fiscal Responsibility and Budget Management target of 3 per cent will remain a distant dream. 


After the global financial crisis and then the pandemic, we are seeing a rise in government deficits and public debt everywhere. India is no exception. If anything, the rise in debt to GDP ratio from 81 to 85 per cent between 2005 and 2021 looks modest in comparison with the increases elsewhere-- 66 to 128 per cent in the US; 39 to 95 per cent in the UK; 26 to 72 per cent in China; and 69 t 93 per cent in Brazil. India’s public debt position looks even better when we take into account the fact that 95 per cent of the liabilities are domestic, and we have the growth-interest differential working in our favour.


3.Inflation will be higher than before: High fiscal deficits can be expected to translate into high inflation. That apart, de-globalisation will happen in a greater or lesser degree. The movement may be gradual, but the direction is clear enough. 

Globalisation was about procuring goods and services at the lowest cost from almost anywhere in the world. Princeton historian Harold James noted recently that there is a historical pattern of globalisation driving disinflation. Alas, it appears the trend towards globalisation is now being disrupted.

Post-Covid and post-Ukraine, every country is reassessing its extent of dependence on outside suppliers from a range of goods and services. The US and its allies are determined to reduce dependence on China to the maximum extent possible as the containment of China has become the West’s strategic priority. 

There has been serious academic discussion in the US about revising upwards the inflation target of 2 per cent so that monetary policy has more room for manoeuvre in the downward direction. In India, the inflation target of 4 per cent threatens to become largely notional. We would be thankful now if inflation falls below 6 per cent.  

4. Self-reliance and import-substitution are a reality: For the reasons cited in (3) above, “make at home” will gain in importance. This will be especially important for leading economic and military powers. As India moves towards becoming the third largest economy in the world with matching military clout, a lurch towards greater self-reliance is inevitable. We need not be unduly apologetic about this trend: We are only falling in line with a worldwide trend. The adjustments in tariffs in the recent Budget, analysts have noted, are aimed at helping domestic industry.

It’s no use bemoaning the trend towards protectionism in various economies, including India. It makes no more sense instead to make a success of schemes such as Production-Linked Incentives. We must find ways to limit abuse of discretion in industrial policy. We need to monitor the effectiveness of the PLI scheme using appropriate metrics. Industrial policy will be integral to economic policy in the years to come.

 Macroeconomic outcomes in the coming years will be governed by the four trends outlined above. 





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