India doesn’t need to stimulate consumption like China
The underlying factors for slowdown in India are very different from that in China.
Concerns about slowdown in the world economy have increased rapidly in the past 12-15 months. Relatedly, the case for fiscal stimulus has also increased worldwide.
Christine Lagarde, the former head of International Monetary Fund (IMF) and now the President of the European Central Bank, argued to co-operate more closely over fiscal policy to stimulate the stuttering Eurozone economy.
China stepped up fiscal stimulus earlier this year and Germany finally hinted at relaxation in its zero-deficit rule. UK’s new Chancellor, Sajid Javid talked about an ‘industrial revolution,’ signalling that fiscal deficit targets are not as important in the era of record low interest rates and faltering economic growth.
With India’s real GDP growth weakening to a seven-year low of 5 per cent YoY in Q1FY20, it is then not surprising that demand for a fiscal stimulus has increased domestically as well. I, however, argue otherwise. Sharp reductions in fiscal deficit and massive decline in bond yields justify a case for fiscal stimulus in most developed economies (except the US). However, since fiscal deficit remains much higher than a decade ago and bond yields have actually risen in inflation-adjusted terms, there is no case for fiscal stimulus in India.
India’s fiscal deficit more than doubled from 4.5 per cent in 2007 to 9.5 per cent of GDP in 2009 and has been broadly unchanged at around 7 per cent of GDP since 2013 (it does not include off-budget borrowings). In contrast, all developed economies narrowed their fiscal deficit as sharply as they expanded immediately after the 2008 recession.
The Eurozone’s fiscal deficit in 2018 was only 0.6 per cent of GDP — the lowest since 2000 and its structural fiscal deficit was 0.7 per cent of GDP, the lowest since data is available in 1995. Similarly, 2018 fiscal deficit was lowest in the UK since the economy posted surpluses at the turn of the century. In contrast, while the US has reduced its fiscal deficit from a record 12.7 per cent in 2009 to around 4.5 per cent of GDP now, it still remains higher than what it was in pre-2007 period.
Further, the risk-free rate of interest on government bonds has fallen dramatically in developed economies, while bond yield remains high in India. Nominal bond yields in many European nations have moved into negative territory recently, but the inflation-adjusted yield has been negative for quite some time. Consequently, while interest payment, as a percentage of GDP, has fallen in the Eurozone, Japan and the UK, it has been broadly unchanged at 4.8 per cent of GDP in India and 1.6 per cent of GDP in the US.
But aren’t interest rates low (or lower) in developed economies because of very easy monetary policy? Not really. Bond yields are a function of not only monetary policy but also of fiscal policy and domestic financial markets. If the government continues expanding its borrowings and the RBI continues lowering the interest rates, bond yields may go up or down depending on the tightness created by these policies in the financial markets.
One of the most important determinants to gauge the ability of the financial markets to absorb fiscal expansion would be the availability of domestic funds in the economy, which are nothing but essentially savings. In sharp contrast to developed economies, not only have household savings fallen in India but also household debt has risen.
Moreover, the credit-deposit ratio (CDR) of India’s banking sector has fallen (very gradually) only in the recent few months after touching almost 50-year high of around 78.5 per cent in early 2019. In contrast, CDR in almost all developed economies in recent months was much lower than the levels reached in 2007.
The underlying factors for slowdown in India, thus, are very different from that in China and developed economies — the latter are trying to encourage consumption and discourage savings by incentivising borrowings by households. Lower interest rates and/or fiscal stimulus, thus, make perfect sense for them.
In India, however, measures to further stimulate consumption or personal borrowings must be resisted because the economy is not facing any demandside constraints. These significant differences between India and other economies must be considered by the authorities while formulating policies.
(The writer is chief economist at Motilal Oswal Financial Services)