From UPSC perspective, the following things are important :
Prelims level : Aggregate demand, components of India's growth
Mains level : Paper 3- Importance of spending of infrastructure
Spending on infrastructure can help kickstart the economy. This article highlights the importance of spending on infrastructure and suggests ways to find resources.
Gloomy prospects for Indian economy
- The IMF estimates the global economy to contract by -4.9 per cent this year.
- It could still contract should the virus not recede in the latter half of 2020.
- As for the Indian economy, growth has been decelerating for the past eight quarters.
- Indications by the RBI suggest that growth is contracting for the first time in four decades.
- We must address the elephant in the room — the need to further aid a demand recovery as the economy begins to reopen.
Components of Indias growth
- Growth in the Indian economy has been dominated by the following components respectively-
- 1) Consumption.
- 2) It is followed by investments.
- 3) Government expenditure.
- 4) Net exports.
- However, consumption and investment demand have been subdued for the past few quarters, dragging down overall growth.
- Keynesian theory suggests that for aggregate demand to increase, at least one of the components of GDP needs to expand.
Declining consumption demand
- These two components were perhaps casualties of a sharp deceleration in credit supply.
- The IL&FS debacle in September 2018 only made matters worse.
- The NBFC sector, suffered from funding crunches leading to a further squeeze in credit supply.
- Freeze in credit supply impacted consumption demand.
- This deceleration is likely to exacerbate going forward.
Declining rate of investment
- Broad-based utilisation levels, as represented by the RBI, dropped to 68.6 per cent in Q3FY20.
- This is well below the 75 per cent benchmark for new capacity addition, implying suboptimal levels of fresh investments.
- A higher rate of investments is essential for sustainable economic growth.
- The deteriorating economic scenario and increasing levels of debt with rating downgrades for industries are likely to aggravate existing problems.
Importance of expenditure on spending on infrastructure
- Government expenditure is the only exogenously determined element in a Keynesian framework.
- The positive push required to aid a demand recovery has to come through the government.
- However, with sparse resources that India has, we must deploy funds that yield a higher return.
- One key area that can provide the necessary support is infrastructure investment.
- A study by S&P Global estimates 1 per cent of GDP spend on infrastructure can boost real growth by 2 per cent while creating 1.3 million direct jobs.
- Historically, countries have used infrastructure to provide counter-cyclical support to the economy.
- Notably, infrastructure has strong links to growth and with both supply and demand-side features that help generate employment and long-term assets.
- India already has an upper hand here.
- Front-loading key projects with greater visibility from the recently announced National Infrastructure Pipeline (NIP) could aid in a quicker recovery.
Special infrastructure bond
- India already has several institutions for infrastructure development purposes from the likes of IIFCL, IRFC to more recently NIIF.
- Taking a cue from China, floating special infrastructure bonds through this organisation to accelerate the funding of the NIP could aid a speedier recovery.
- Further, taking a page from the New Deal and its Reconstruction Finance Corporation, this institution’s ability for greater leverage can be used to make amends to our credit channels.
- This ability could also be used for the development of state government and urban local body bond markets.
- This could help businesses and bankers overcome risk aversion and bring back trust in the system while financing new paths for growth.
Consider the question “Highlight the role of consumption and investment as the two largest contributors to India’s growth and explain how spending on the infrastructure could help revive the economy hit hard by the pandemic”
The exogenous component in the form of spending by the government could step-in in a greater way, perhaps because, it is the only one that can.