Finance Minister Nirmala Sitharaman has once again emphasized that the government has an ambitious capital expenditure (CAPEX) program in the current fiscal to spur demand and boost economic growth. The Modi government’s re-dedication to the Keynesian plan comes in the backdrop of a rethinking of large government spending in the face of inflationary pressures in developed countries, particularly the United States. Will the government crowd-in or crowd-out the private sector, and what does that mean? read on.
Why is the government giving so much emphasis on capital expenditure?
The Indian economy is slowly recovering from the devastation of the pandemic. In fact, it is now already the fastest growing major economy in the world, having grown over 8.7% in the last fiscal and is projected to grow around 7% in this fiscal. The government is looking to boost this early economic recovery amid global macro-economic headwinds. It plans to do so through an ambitious capital expenditure program this financial year.
Capital expenditure refers to investment by the government or private businesses in upgrading existing or new physical assets. Now, as businesses expand, capex has a manifold effect on the economy, creating demand and driving away animal spirits.
It was a strategy the government adopted – a trend also seen in other countries – to shield the economy from the effects of the pandemic as much as possible.
What does the government expect to gain from capex?
Sitharaman and her team are hoping that the thrust on capital spending will ease supply-chain bottlenecks and improve demand. Therefore, while capital expenditure can add to the productive capabilities of the economy, fueling long-term growth, it will also boost job creation and consumption.
In the last budget, Sitharaman announced a big jump in the government’s planned capital expenditure for this fiscal. In 2022-23, the capex expenditure of the government will be 7.5 lakh crore (even more if you add grants-in-aid for capital assets, including MGNREGA) – a 27% increase from the estimates of the previous year (2021-22). Importantly, Sitharaman expects this to increase private capital expenditure in the economy. The government has ambitious plans to sharply increase spending on expressways, logistics parks, metro systems and housing – much of this work will be given to private contractors.
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Can the government exclude the private sector?
How times change! For a long time, the government has been wary of excessive borrowing and spending, even on capital expenditure, worried about private sector congestion. But clearly there has been a change of mindset in North Block. Indeed, Sitharaman’s team has tried to address the government’s concerns in the private sector’s share of national savings. Last year, SEBI whole-time member G Mahalingam said, “There is no doubt that a good part of the bond market is filled by government issuances.” Mahalingam could not have been more vigorous. There is no doubt that the corporate bond market… which means manufacturing companies are dependent on banks as a source of capital.”
The government openly disagreed with Mahalingam. Krishnamurthy Subramaniam, the then chief economic adviser, said it was a typical argument that “reliance on the pool of savings being stable. There was mounting evidence that savings were “cyclical with growth”, Subramaniam said, if government spending. What’s more, it accelerates growth and increases savings, thereby crowding out private investment.
Can government spending revive private capex?
Since the global financial crisis in 2008, private investment has been stymied, largely due to the dual balance sheet problem in the banking and corporate sectors. To revive private investment, especially in the manufacturing sector, the government has taken several measures in recent years, from the introduction of the GST and the Insolvency and Bankruptcy Code (IBC), to infrastructure building. Sitharaman also unveiled the audacious corporate tax cut in 2019, reducing the base rate from 30% to 22% and for new construction companies from 25% to 15%. Corporate tax rates in India are now among the lowest in the world. But the move has not yielded results, perhaps in part due to the Covid-induced economic slowdown.
What is global experience?
Globally, aggressive fiscal and monetary policies kept economies afloat during the pandemic. Simply put, governments went on a spending spree while central banks cut benchmark rates to stimulate demand. Some economists believe that this could lead to potential overheating in the global economy, which could lead to an increase in inflation. Large government spending is now being reconsidered in developed countries. For example, in the US, President Biden is now talking about reining in government stimulus to the economy to reduce inflation. Sitharaman is trying to contain the deficit by cutting government subsidies, including on MGNREGA, a politically controversial move.
Can the government’s capital spending increase inflation?
The Reserve Bank of India has started increasing the repo rates to curb demand-pull inflation. But the rise in inflation in India is triggering a rise in commodity prices partly as a result of global supply-side constraints. A normal monsoon will help bring down the inflated prices of food items. Sitharaman allayed concerns over inflation, arguing that India is better off than other countries.