Low govt spending the main impediment to real economic stimulus in India

Even with a 68% jump in long-term market loans, Centre hasn't been able to raise govt spending remarkably; quality of expenditure has suffered too, with capex 2% lower than last year

Investopedia, an online encyclopaedia of economics and finance, says this about stimulus, citing the work of the legendary economist John Maynard Keynes: 

“Fiscal stimulus refers to policy measures undertaken by a government that typically reduce taxes or regulations—or increase government spending—in order to boost economic activity.”

“Monetary stimulus, on the other hand, refers to central bank actions, such as lowering interest rates or purchasing securities in the market, in order to make it easier or cheaper to borrow and invest.”

Finally, “Economic stimulus is action by the government to encourage private sector economic activity by engaging in targeted, expansionary monetary or fiscal policy based on the ideas of Keynesian economics.”

In the nine long months of the coronavirus pandemic to date, action has happened on both the fiscal and monetary fronts. Experts think that monetary policy has been partially effective, with the lowest ever short-term interest rates in India’s history, highest ever forex reserves that will cover imports for a year. Yet, there are hardly any takers for long-term project and capital financing loans. 

On the fiscal front, the central government announced three rounds of stimulus: in May, October and November, with a slew of measures involving direct addition to Budgetary spending, and nudged banks and financial institutions to lend more to small businesses. 

But has it resulted in a fiscal stimulus according to the definition by its theoretical originator, the Nobel laureate Keynes? Theoretically, it has not. 

What ails the fiscal stimulus

The Union government led by Narendra Modi, has spent only 0.4 per cent more in April-October 2020, compared to the same period of the previous year. To be fair, even a matching of last year’s spending is commendable when tax revenues are down 16 per cent and total receipts to the Union have dropped 24 per cent. 

But even with a 68 per cent jump in long-term market loans, the Centre hasn't been able to increase government spending substantially, short of a fiscal stimulus, if we go by the definition. 

The situation is more serious if we look at the quality of spending from the investment point of view. Capital expenditure, which has a high fiscal multiplier, or the ability to accelerate non-government spending, is 2 per cent lower than last year. 

The stimulus till October has only matched last year’s revenue expenditure. While capex is on productive assets such as roads and railways, metro projects, and defence equipment, revenue spending refers to cash support and rural schemes, salaries and pensions, and interest outgo, among other measures. 

Also, it must be noted that the third part of the stimulus package by the Centre is yet to get reflected in official data presented here. 

Economists, however, predict spending will revive in the November-March period, giving a fillip to the stimulus.

“We expect the Union government’s total expenditure to be Rs 30.2 trillion in FY21, despite the fiscal support measures that have been announced so far. This translates into a projected expenditure of Rs 13.7 trillion in Nov-Mar FY2021, which is a considerable 33.6 per cent higher than the outgo in the last five months of FY20,” Aditi Nayar, principal economist at Icra, said in a note. The amount excludes recovery of loans. 

States, on the other hand, have been weaker in stimulating the economy than the Centre. Their total spending has been 4 per cent less than the last year in the first seven months of financial year 2020-21. 

Here again, their capex has massively lower by 26 per cent in the period. When investments in the economy as a whole are 28 per cent lower in April-September compared to the previous year, government investments act as catalysts for private spending to fire. They are also key to the success of the Rs 100 trillion-National Infrastructure Pipeline announced by the Centre. 

Having said that, experts feel that a direct comparison with previous years’ spending might not be an accurate one. 

Official data on the fiscal balances of Union and state governments “tend to obfuscate as much as reveal,” due to off-balance sheet items, Ananth Narayan, senior India analyst at Observatory Group wrote in a November 2020 article. 

“While total expenditure shows a year-on-year drop of 0.7 per cent in April-September period, some expenditure that was captured in central books this time last year has now been taken off the government’s balance sheet,” his article noted. 

This means that this year’s spending looks lower to the extent of off-Budget items clearly mentioned in the Budget 2020-21. 

The road ahead

But going forward, to make sure that the governments—both, Central and the states—stick to the Keynesian definition of fiscal stimulus, they would either have to depend on a good jump in revenues in Q3 and Q4 of FY21, or borrow more than the planned borrowings from the market. The third option, of saving expenditure in some ministries to spend more in others, would be the golden mean if the two means—revenues and borrowings—do not materialise. 

The first weapon may fire to the extent of economic revival. In Q2, India’s gross domestic product shrank by 7.5 per cent, recovering faster than the general expectation. If this trajectory continues, revenue growth may improve in the second half of FY21. 

On the second means, the Centre has already borrowed 68 per cent more than last year in April-November, and states’ market borrowings have risen 46 per cent in the same period, according to reports by Care Ratings and the State Bank of India. 

But looking at the pattern of government borrowing till now, the bond market is putting more borrowing than already planned, off the table. 

“The market is not expecting any additional borrowing. The T-Bill issuance was also lower than the last quarter,” said Hemal Doshi, vice president, Treasury, at SBI DFHI Ltd. 

Only the third option, which means lower spending that the last year, remains.  

The new cash expenditure management plan put in place by the central government limits spending. Introduced in April for Q1, it was extended to Q2 in June, and to Q3 in September. The rationing of spending was done to use cash more effectively in priority areas, and ensure that no amounts remain idle after Centre’s release. 

The spending of as many as 52 departments in a quarter is capped at 15 per cent of the Budget allocation (Category C). They can thus spend only 45 per cent of annual allocation in nine months, or in 75 per cent of FY21. Next, 23 departments are allowed to spend 20 per cent per quarter this year, capping their nine-month limit at 60 per cent of Budget estimate (Category B). Priority areas such as health, farm sector, food and consumer affairs, rural development and railways have been exempted from these revised guidelines (Category A).

Further, there is an all-ministry wide cap on spending in the last quarter of any financial year, at 25 per cent of Budget estimate. This would make most ministries spend 70 per cent to 85 per cent of their allocation only, substantially reducing the overall expenditure of the central government. 

The total spending will rise only if the government makes more than good on the priority departments in Category A.