Will government spending continue to drive growth in the Union Budget?

When the fiscal deficit touched 112% of the full year target for 2017-18 by the end of November itself, there was a major concern. Just a month before that Moody’s had upgraded India’s sovereign rating citing fiscal discipline and growth potential as the key parameters. Ironically, S&P had refused to upgrade on the basis of the very same factors. The broad concern was that fiscal spillage at this point of time may look incongruous with a rating upgrade which came after 2 consecutive years of fiscal adherence. That brings us to the critical question of whether government spending will continue to drive growth and whether it will continue to spur growth in Union Budget 2018.

Falling growth momentum is the primary concern for the government..
You can blame it on GST, weak market conditions, lag effect of demonetization or simply overcapacity in the industry; the bottom-line is that growth has been slowing. Consider the chart below..


                                                        Source: CSO

As the chart clearly depicts, the growth has been slowing consistently over the last few quarters. The reasons are many. Demonetization created a huge gap in rural demand and rural spending and the lag effect is still being felt. There is an adjustment lag when it comes to GST. Especially exporters were in a tight spot as the delay in GST refunds locked nearly $10 billion worth of working capital The SMEs that support the export oriented units were the worst impacted and that was the real reason for the slowdown in growth. The only silver lining of growth was visible in social and public services where the government has a big contribution to make. Therefore government spending is likely to continue in a big way to ensure that the growth momentum, at least, does not falter further from here.

Infrastructure still requires a big push..
When the Rakesh Mohan Committee was first appointed in 1997 it had estimated that India would require nearly $100 billion to bring Indian infrastructure to Asian standards. By 2015 that figure has moved up well past $1 trillion. The big challenge now is to focus on areas where the government can make a difference. For the fiscal year 2017-18 the allocation to infrastructure was in excess of Rs.3.96 trillion. That includes a big thrust to roads, expressways and highways. Indian roads are a major anomaly. Highways constitute just about 10% of India’s road infrastructure but account for over 50% of the goods movement. That can be reconciled only if the road highway infrastructure across India can be fast tracked. The number of kilometres of roads laid each day is substantially higher than in the previous years. That would not have been possible without a big government focus on infrastructure spending.

Government spending on rural India has to take precedence.
The latest quarterly advance estimates put the full year GDP growth at just about 5.7% but what was more disappointing was that agriculture grew at just above 1%. This is substantially lower than the intended 4% that was being targeted for agriculture. Rural India was the worst hit by the demonetization exercise. Additionally, most farmers have been forced to sell their output below the MSP and that is almost making the MSP look like an incongruous concept. Government will have to make provisions to compensate farmers for MSP and also for loan write-offs in case of farm distress. Lastly, the government is also expected to spend heavily on post harvest infrastructure like cold storages, last mile transport and e-markets to reduce wastage. The rural allocation is likely to remain elevated this year too and that is the only answer to farm distress.

Government allocation to defence..


                                              Source: World Bank

The above chart captures the share of defence spending in India as a percentage of GDP. Ironically, the total share of defence spending in GDP is almost at the lowest point in the last 50 years. With hostile neighbours and perpetually shifting power equations in the world, India’s defence allocation is likely to go up sharply in the next few years. There are two big shifts we see in this budget. In the last two years the growth in defence spending has purely come from a rise in revenue spending. In fact, growth in capital spending in defence has been negative. That is likely to change in this budget with a major capital allocation. Secondly, this budget is likely to make a big start to in-sourcing of defence manufacture and defence services so that precious foreign exchange can be conserved.

The moral of the story is that government spending will continue to drive overall growth. In fact, the government should be spending a lot more on healthcare and primary education, where India lags behind even South Asian nations. Remember, government spending has strong externalities and normally has a multiplier effect on productivity. Union Budget 2018 could actually signal that shift!