Govt must borrow for infra and spend to revive the economy

Without a near-term spending of Rs 4-5 lakh crore, it is going to be difficult to even reboot the economy

That Larsen and Toubro should see a 40% slump in orders in the June quarter, or that Bajaj Auto’s operating profits crashed 66%, is not surprising since the country was closed down for much of the time. But, the lockdown has left businesses debilitated and thousands jobless. There is no way the economy can get back on its feet without some serious government support, a chunky dose of investment spending accompanied by some consumption stimulus. Else, we are staring at serious damage to banks’ balance-sheets and irreparable damage to corporate balance-sheets.
Over-leveraged balance-sheets in a slowing economy have left corporate India in bad shape.

Aggregate profits plummeted 38% last year (for 1,691 companies excluding banks and financials) without any disruption and off a measly 1.5% increase in 2018-19. Exclude Reliance Industries and TCS, and the slump was 45%. With investment slowing for about four or five years now—save the M&A via the IBC route—demand has decelerated and few fresh jobs have been created. There is little chance of companies committing resources in this environment, most promoters cannot even contribute to equity capital. Lenders too are short of capital and have turned increasingly risk-averse as ratings agencies warn of more defaults as they downgrade some 20 companies every day.

Meanwhile, once-thriving businesses, like Vodafone Idea, that employ thousands and are key to developing India’s shabby infrastructure, have been ruined because the government chooses to change its regulations arbitrarily to favour players. Indeed, even having brought Vodafone Idea to its knees, the telecom regulator is unrelenting. Given how the stimulus package rolled out by the government in mid-May was more than underwhelming—with less than 1% of a fiscal impact—and no sign of a follow-up is in the offing, chances of the economy contracting as much as 9-10% are high.

The contraction would be led by decelerating consumption growth, which fell to 7.2% in FY19 and 5.3% in FY20, and not only because businesses are closing down. Even if the job-market improves post the lockdowns with factories and establishments reopening, wages are expected to be moderate. As Pranjul Bhandari, chief economist at HSBC, India, points out, the wage outlook could be dim for three reasons.

For one, as during demonetisation, more jobs may eventually be generated in rural India where wages tend to be lower than in urban India. Two, it is possible there will be a second round of pandemic-led labour market weakness, driven by job or wage losses in the first round. Given the nature of the pandemic, Bhandari argues, this could show up as weaker urban job opportunities in India, perhaps sending some back to their rural homes, and again, weighing on wage growth. Three, given both rural and urban wages are driven by economic growth, HSBC’s expectation of India’s post-pandemic potential growth falling by one ppt to 5% does not bode well.

A potential growth of just 5% implies that the promise of India’s huge consumer catchment—which is what draws foreign investors—will soon fade away. A 4-5% growth economy is a lot less attractive than one that is clocking in at 7-8%; no investor is going to risk regulations that are unreliable and red tape that is regressive unless the returns are more promising. Indeed, post the Vodafone Idea episode, global corporations will think twice before they invest in India. Also, as economist Pronab Sen has pointed out, the GDP data doesn’t capture the informal economy effectively enough since it is an extrapolation of the organised sector’s performance; consequently, given it is the informal sector that has been more badly bruised, it is possible our economy is actually trending slower than the numbers suggest.

Right now, though, even 5% looks a tall ask since there seems to be no way out of the vicious cycle; private sector investment could altogether disappear as businesses get into cash-conservation mode. With the government’s revenues dwindling, it simply won’t have the wherewithal to invest. How then will new jobs come about, and households spend more? Much of middle-class India—except for government employees—is going to be more worse off in the next two years. Leveraged consumption, of the kind that we have seen in the few years before the collapse of IL&FS, can be safely ruled out given how cautious banks are, and given most NBFCs simply don’t have the wherewithal to lend.

The government should raise money—in a corporate entity—via long-term retail tax-free bonds at 5% and use it for infra projects and to complete stalled real estate projects. If stranded real estate projects are taken over and finished, that can catalyse the economy by creating jobs and demand for goods. In the process, an urban MGNREGA scheme can be launched. Without a near-term spend of Rs 4-5 lakh crore, it is going to be difficult to reboot the economy; thousands of small units will simply perish, sectors such as restaurants, aviation, tourism and hospitality, which employ large numbers will be battered, and there will be a spillover effect on other sections of the economy. The banks will bear the brunt of the stress as their balance-sheets weaken. We are staring at a twin balance-sheet crisis all over again.