Wednesday, October 25, 2017

Indian economy gets an implicit stimulus

After much criticism of the government over the deceleration of economic activities following demonetization and the rollout of GST (FY2018 Q1 growth slumped to 5.7%), the government has announced two major plans:

1. Recapitalization of state-owned banks: IRs2.11 trillion (IRs2 lakh 11 thousand crores) recapitalization package consisting of IRs1.35 trillion from sale of ‘recapitalization bonds’ and IRs76,000 crore from budgetary support and ‘market-raising’. Initially, the government had planned IRs20,000 crore bank recapitalization strategy for FY2018 and FY2019. This is a major step to ‘unfreeze’ the credit market where by banks are saddled with high non-performing assets (around IRs7.7 trillion) and major corporates high on debt already are not able to borrow with restructuring their loans. One question that looms large is that how is this not going to add to the fiscal deficit target of 3.2% of GDP for FY2018 (except for IRs18,000 already committed under Indradanush Recapitalization Scheme over the next two years)? Isn't recapitalization a form of net lending by the government (okay, you don't pay interest on it immediately after issuance but in subsequent years both interest and principal payments will need to be factored in)? CEA Arvind Subramanian says that recapitalization bonds do not impact fiscal deficit as per IMF accounting rules but will increase government liability/debt.

2. Approval of IRs6.92 trillion worth of highway projects: The plan is to construct 80,677 km of highways over the next five years. It aims to crate 14.2 crore man-days of jobs and would ensure substantial delegation of authority to enable accelerated implementation. This includes BharatMala projects (34,500 km of roads with an investment of IRs5.35 trillion) consisting of economic corridors, inter-corridor and feeder route, border roads and international connectivity, and coastal roads and port connectivity, among others.

One unanswered question is that will these implicit stimulus measures turn around the slumping economic activities, especially in FY2018? Both the reforms outlined above are medium-term measures and their effectiveness would depend on how fast and effectively they are implemented (coupled with administrative and operational reforms at PSBs and execution of capital projects).