In Infrastructure, The Animals Must Trust: Budget 2021 and the Modi Government’s Keynesian Push

Unprecedented times call for unprecedented policy decisions. The Modi government has been heavily criticised in the past nine months for its piece-meal and inadequate approach towards steering a pandemic-stricken economy towards recovery, but has stuck with its approach of letting animal spirits shoulder bulk of this recovery process. Budget 2021 in many ways is principally no different, but marks a major policy shift. While being incremental to many of the policy packages announced earlier in 2020, it sends a very strong signal that the Modi government has abandoned the cause of welfarism as a priority, gone back to the drawing board and effectively picked up an introductory undergraduate macroeconomics textbook in its quest for “once in a hundred years” solutions.

While Keynes was never invoked in the 108-minute long speech made by the Finance Minister, the evidence of an outright Keynesian outlook was extremely clear. And in turning to the basics of Keynesian economics, the government has hedged almost all its bets of economic recovery on one pillar – infrastructure. This thrust provides three key messages. First, the government recognises the lack of private participation in infrastructure spend in the recovery thus far. Second, it perceives additional capital investment in key infrastructure sectors as a source of increasing attractiveness to domestic and foreign investors. Third, growth is the only way to ensure development while India recovers from the pandemic. Let’s deal with each of these implied messages in the budget, one at a time.

First, the government has planned not only for an increase in capital expenditure on physical capital assets by almost 34% YoY with almost 5.5 lakh crores invested in roads, railways, freight and economic corridors, but also combined this with its 1.97 lakh crore PLI subsidy scheme to spur investments in 14 manufacturing sectors. Some of these annual allocations are unprecedented in terms of their historic context. The idea behind this has been simple. The problem of private appetite in contributing to physical capital formation has been a problem not just during the recovery phase last year but also in the run up to the pandemic. The government introduced the National Infrastructure Pipeline in this regard in order to provide some fillip to private investments in infrastructure, which now sees itself expanded even further as a signal from the government that the private sector needs to unshackle itself in terms of potential capital investments.

Second, much of the increased expenditure in infrastructure has been planned around transport and logistics which has been considered a key bottleneck in terms of facilitating sizeable investment and commercial activity in the country. Modernisation and expansion of freight corridors, expansion of economic corridors, establishment of Mega Textile Parks, along with investments in urban infrastructure and the power sector are all indicators that the government hedges its bets not just on making India an attractive logistical destination for global investors, but also believes that these enhanced sentiments will trickle around to spurring domestic investments in the country as well. This is what text-book economics in any introductory class would teach us, as a simple and effective solution to spend our way into long term assets, out of a recessionary phase.

Third, the government has made very clear that we are not seeing any stimulus checks or cash transfers, as in the West. While the arguments for and against demand side vs supply side policies abound, the rationale in the minds of the top government officials is very clear – central exchequer at the moment is better utilised by immediate expenditure in asset creation and indirect income generation rather than direct cash transfers to raise disposable incomes and savings in the hands of people. The lack of discernible push on additional subsidies (apart from food) also made it very clear that the focus here was simply a short-term response to the recessionary phase we are currently undergoing where capital expenditure and the associated accelerated growth is the most viable and bang-for the buck form of welfare that the people in the country deserve in the short run.

However, even in this seemingly fool-proof and simple plan, there are two potentially significant roadblocks. Firstly, in the short run, the government believes that this massive text-book push to infrastructure will be a plausible solution to some of the major growth problems India faces during this pandemic, but a major chunk of the country’s employment and investment capacity today lies in the hands of the MSMEs. These enterprises have already been crying for a much more dedicated package of reforms and outlays aimed at them, which has been partially ignored by the governments thus far. This budget does no better with a meagre 15,700 crore allocated to them along with a slew of import substitution and tariff policies. The key to creating employment around such a massive infrastructure push massively lies in unlocking the potential of millions of these MSMEs which have been starved off cash and institutional support for a good period of time now. While it is logical to expect that markets and animal spirits in the India Inc. will react favourably to the budget, the sustenance and creation of new small and medium scale enterprises remains key to the success of any policy which aims to spur growth as a first-hand outcome.

Secondly, with no major increases in direct or indirect taxes, the major focus of the government this year will be debt-driven growth. While our fiscal deficit stands at 9.5% of GDP as of FY21, the aim of the government in the medium term through a combination of growth and inflation will be to finance much of this investment via a combination of borrowings from the open market. The optimism of the government is clear when they expect a 2.7% reduction in fiscal deficit (setting a target of 6.8% for FY22) simply through enhanced growth in the economy, despite maintaining almost 12 lakh crores worth of market borrowing. Under current circumstances, a larger fiscal deficit is being perceived world-over as a sign of a pro-active government. However, there are three issues here to keep in mind.

First, there is a potential of enhanced public sector and government borrowing in the economy to “crowd out” private borrowing and hence limit the scope of private debt in order for the private sector to partake asset and income creation more broadly as the government expects. Domestic credit has stagnated and the RBI has warned of record high NPAs for the coming year – both signs of almost zero appetite in the market to take on any debt. In fact much of the liquidity injected by the RBI into the system as part of the Atmanirbhar Bharat package remains in limbo as banks are reluctant to lend and privates are scared to borrow any further, thanks to stifled demand. Since most of the government borrowings are from domestic markets such as Small Savings Funds in the absence of a vibrant international bond market for the Indian government, this is a dangerous scenario that the government must try to avoid and actively monitor.

Second, the government has re-introduced the prospect of Infrastructure and Real Estate investment trusts raising debt from FPIs in order to finance even greater investments. Emerging markets lead the world economy in terms of building a wave of massive debt which under circumstances of lower growth become extremely dangerous to investment sustainability in these economies. While India’s foreign debt tallies today are not as high as many other emerging markets, should the government and private trusts step into international markets to finance its growth via aggressive debt, it risks India in becoming entangled in this wider tsunami of public and private debt which is piling up in emerging markets across the world.

Finally, the Budget introduces the pathway to create yet another Development Finance Institution (DFI) to mobilize almost 5 lakh crores worth of investment into the infrastructure. The Indian economy is just recovering from the IL&FS crisis which has battered the liquidity in the domestic credit and bond markets. This new DFI presents yet another massive foray of a government institution into domestic debt markets to raise massive amounts of loanable capital for infrastructure. India already has the National Infrastructure Investment Fund (NIIF) which mobilizes global sovereign debt fund resources into the Indian infrastructure sector, but this new DFI aims to take major burden off from the shoulders of already hesitant banks on infrastructure investments. Without fixing the issue of liquidity and confidence in the system, this might turn out to reopen and deepen old wounds to the economy from the IL&FS crisis, if not tread carefully.

The die has been cast. Narendra Modi and his coterie surely see this as his FDR moment. Should this bet on infrastructure as bugle for animal spirits and market forces succeed, then the government sees itself not only overseeing the fastest growing economy in the world for FY22 but also creating massive clout for many more major structural reforms which are either in the pipeline, or have been set on the back-burner thanks to the Covid pandemic. The last six years were a festschrift to welfarism, and the pandemic has now provided us a portal toward the primacy of growth above everything else in the economy for the next six.

(Originally published on 2nd February, 2021)

Category: Budget 2021 | Published on: December 24, 2021