Development and structural reforms tend to dominate thinking on macroeconomic policy in India, which is understandable given the growth imperative. Post the pandemic macroeconomic policy helped induce a robust recovery by effectively smoothing external shocks — the cycle also affects growth.
Slowing government spending during the election months is one reason for the slowdown in the economy. Upto the end of November, the Centre had spent only 46.2 per cent of its capital expenditure target compared to 58.5 per cent this time last year, although its revenue expenditure is about 1 per cent higher. States have spent only Rs 0.88 trillion of the Rs 1.5 trillion made available for capex. So, does countercyclical fiscal policy require the government to spend more or to cut taxes? It should certainly meet its spending targets but continuing fiscal consolidation is also essential since India’s combined fiscal deficit is above 7 per cent of GDP — one of the highest in the world. Interest payments eat up as much as 19 per cent of the Centre’s expenditure. Falling debt and deficit ratios are required to build fiscal space, reduce risk premia and interest rates spreads.
Since the slowdown followed that in public investment, despite revenue expenditure being maintained, it is clear that better quality of spending itself provides stimulus — so increasing the share of public investment must continue. Efficiencies in spending can release resources for this. But incentives are required, more than resources, to increase investment. For example, conditionalities that have helped increase states’ capex must continue.
Corporate investment has not risen much despite tax cuts, showing that resources alone do not deliver. High growth and profits have raised the ratio of private corporate savings from around 1 per cent of GDP before the 1990s to an average of 10.7 per cent after 2005-06. But private sector fixed capital formation peaked at 27.5 per cent in 2007-08, then fell, averaging only 21.5 per cent over 2015-21. As a result the share of corporate non-business income has increased four times. The budget could consider a tax on non-business income offset by an investment tax credit, in addition to inducements to raise employment.
Just as domestic savings are underutilised, so are foreign savings. Inflows to the economy normally exceed our current account deficit, which is the excess of investment over savings financed by foreign savings. So it is investment, not resources, that is the constraint government has to act on. The K-shaped recovery and consumption as the demand constraint seems overdone. A number of recent independent as well as official surveys show good overall consumption growth (8-9 per cent last year, GDP data shows 7.3 per cent) and recovery in lower income groups.
Studies show the Indian middle class broadly defined is large, but numbers are concentrated at the bottom. Thus 31 per cent (432 million) were in the Rs 5-31 lakh per annum bracket in 2021. The market for FMCG goods is that size. But one estimate of those with annual income of Rs 8 lakh or more is only 5 per cent (60 million) in 2023. Since income tax payers remain low, studies such as those of Piketty that use income tax data, give unrealistic tiny middle class numbers.
But corporate premiumisation strategies are focusing only on the narrower top. It is not surprising that they find demand growth to be slow. Poverty has fallen to 5 per cent. A characteristic of Indian middle classes is mobility, especially at the lower end. Products created for these price-sensitive groups will do well. Income tax cuts for lower slabs can further increase their spending and faster than the government can spend. It is also fair since inflation increases real taxes while eroding real incomes. But the main focus of tax reform must continue to be on simplification, removing loopholes and increasing the base.
Recent surveys show the food share of consumption has fallen below 50 per cent, and even in that, processed foods have the largest share, followed by milk products. The cereals share has fallen below vegetables. Demand for diversified foods is rising as government schemes transfer more to lower income groups. Vegetable supply is the most disorganised. It is no wonder the economy has struggled with price spikes over the past several months.
But agricultural marketing reforms are progressing at the state level — 26 states have adopted private markets and allowed direct farm gate sales, although only 14 have notified the rules. There is also movement on other measures to develop agricultural supply chains and a unified market. Research shows that farmers who diversified production made more profits than those who relied on MSP sales. Easing sales of diverse produce is the best way states can help their farmers.
Last year the budget had proposed a framework for better coordination with states. Food supply should be a focus area. Another is simplifying regulations. The Centre tells us they have removed thousands of archaic laws, but businesses do not find life to be any easier. The simplification has to percolate down to the second and third tier of government, reaching local officials who interface with firms. States are more open to reforms as they compete for GCC centres.
most read
As cost push inflation falls, interest rates can come down. Low real interest rates are one of the most effective incentives to increase demand, with the large number of India’s young buying houses and equipping them. While resources are not a bottleneck, their cost and opportunity cost matters. The argument that conservative macroeconomic policy is required in response to Trump and geo-economic fragilities, goes back to the old way of thinking that neglects our ability, demonstrated during the pandemic, to counter external shocks using our size, economic diversity and strategic policy stimuli.
Budget priorities, to be aligned to the needs of the economy, must facilitate an improvement in conditions of production, so more can be produced and made available at lower prices. Just resources will not achieve results, well-designed incentives are essential.
The writer is former member, Monetary Policy Committee and Professor Emeritus, IGIDR
Discover the Benefits of Our Subscription!
Stay informed with access to our award-winning journalism.
Avoid misinformation with trusted, accurate reporting.
Make smarter decisions with insights that matter.
Choose your subscription package
