The Union Budget
for the financial year 2021-22 is to be presented to Parliament in less than a
month from now. The focus would be on the stimulus the government would give to
different sectors as they seek to recover from the lockdown induced by the Chinese
pandemic. The focus of the government in 2020 would have to be ensure the firms
and households remain solvent during the pandemic lockdown but as the
vaccinations are underway, there would be direction necessitated for revival of
the economy. The economy must shed the past and look towards the future. An important
indicator would be however the boost to the consumption. The economic revival
in India has to pick either through a growth in consumption or growth in investment.
The government expenditure has ensured the economy remains stable in turbulent
times and has saved further blushes for the economy. it is time to revive the
other components of aggregate demand.
Investment is
sought to be increased through Atmanirbhar projects along with Make in India. These
however will have a significant time lag in demonstrating results. The relocation
of firms from China to India will make this movement steady. Chinese growth
through the eighties till a few years before was essentially driven by the
investment. China encouraged domestic savings which were channelized into
investment producing goods which were then exported to the rest of the world. The
sheer quantum of exports ensured China would remain in current account surplus
despite huge oil imports to feed its growing economy. The current account
surplus would necessitate capital account deficit which in other words would
imply the increase in Chinese investment abroad. This ensured the increasing
Chinese control in overseas economic affairs. While India would in the long run
look towards investment as its growth driver, it has to complement it with
consumption. Investment as growth driver is not something new. Investment as
growth driver resulted from the Harrod-Domar model of growth in part inspired
by the Soviet experience (later proved false). It advocated creation of capital
on a large scale which would act as a multiplier for GDP growth in developing
world as they sought to rebuild their economies from the travails of
colonialism.
Yet the
investment driven growth model found itself short of driving the miracles it
has promised. The answer lay to a good extent in the resources essential to
drive the investment. The manpower resources were not skilled enough to man the
systems. Secondly, the markets were robust enough domestically to absorb the
production. The foreign investment was discouraged on fears of colonization
whereas the export promotion too was discouraged. While Japan or the East Asian
tigers drew through export promotion, countries including India based their
premise on import substitution. They focused on Atmanirbhar but with
protectionist tendencies. The Atmanirbhar or Nehruvian era discouraged imports,
focused on finding domestic alternatives even though inefficient and thus with
compromises on quality ended the potential for exports. Even today, domestic
consumption is deemed to be inferior. There are many retail outlets which
promote their goods as something deemed for exports but diverted for domestic
consumption as an exception. The mindset to substitute everything foreign did
hinder the economic growth thus the limitations for investment led growth of
Harrod Domar. China, South East Asia, Korea, Taiwan, Japan all went
significantly into investment driven growth and not consumption oriented one. The
problems of Japan today to an extent lie in the inability to increase the
consumption in what essentially has been savings driven one. The marginal
propensity to save is higher relative to many other countries, something that
was observed in China during its growth years.
The growth model
in the US on the other hand was driven by consumption. US has traditionally been
a consumption rich country and so was Europe as a continent. Therefore, their
emphasis was always on consumption. This was perhaps the reasons wherein the
focus was on tax cuts or on interest rates. The monetary school that arose in
the US emphasized on interest rate changes to boost consumption as also
investment. While consumption focuses on the consumption in the current period,
the investment would emphasize on capital creation to produce consumption goods
at a later date. While consumption patterns would be relatively stable, the
investment patterns would be relatively volatile. The consumption patterns
would do well with lower lending and lower deposit rates, the investment
patterns too would depend on lower lending rates that translate into cheaper
source of funds and thus increased capital creation. The investment moved away
from US towards East Asia and later China in pursuit of cost savings which
underpinned on labour arbitrage something the Indian IT and services industry
built itself upon.
As India
prepares its budget for the coming financial year, it would have to be a reset
of the economy. Without doubt, the Indian government emphasized on structural
reforms during the pandemic period rather than focus on stimulus sector wise. There
were stimulus measures directed at specific sectors but they were no doubt
short term rather than long term. The government perhaps wanted to tide over
the crisis and focused on short term measures to alleviate the same. The budget
is the opportunity for the government to redirect towards consumption building
measures. The consumption measures would obviously necessitate the tax cuts and
interest rate cuts. The higher inflation rate ostensibly driven by the pandemic
induced supply cuts meant that the RBI had to keep the interest rates high as
part of inflation targeting. Inflation targeting will have to die if not dead
as demonstrated by the pandemic times. Therefore, the interest rates will have
to be structured differently and aligned to different benchmarks rather than
the current inflation targeting approach. The current approach implies
inflation to be between 2-6% and if it breaches on the higher side, interest
rates have to rise which would be against conventional wisdom when the ability
to borrow and repay funds would be at the lowest thus necessitating lower
interest rates.
Therefore, the
current budget would be keenly looked upon for continuation of radical reforms.
the past budgets of the NDA government have been lacklustre in terms of reform
announcements. This is an opportunity to shed the same and turn a new leaf. The
dynamics of investment and consumption need to be redrawn in the current
context. The onus is both on the government and the central bank.
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