Budget 2021: Dear FM, forget the deficit. Spending is the only way out of this crisis

After hesitating for nearly six months, the Centre now appears to have decided to speed up spending. Government spending, which had remained flat till September, surged 50% y-o-y in November and is expected to grow strongly in December too. On the back of this change in stance, Q4 2020 GDP is expected to grow significantly stronger at 2% (on a year-ago basis) and for the full year, contract 6.5%.
It is unfortunate that GoI waited until tax revenue began to recover before easing its purse strings. To be fair, this is what most emerging markets do: run fiscal policy pro-cyclically rather than countercyclically as it is supposed to be done. In 2020, we did see some notable exceptions, such as in Brazil. But funding constraints and inadequate automatic stabilisers have forced fiscal policy in most emerging markets to add to economic volatility rather than dampen it.

India is no exception. It should have increased spending in the first half of this fiscal year when the economy acutely needed the support and not wait for the infection rate to subside, mobility and activity to start normalising, and tax revenue to recover before doing so. While the adage ‘live within one’s means’ is good advice for individuals and governments alike, it is mostly intended to hold over the medium term. As an instrument of macroeconomic policy, governments are expected to alter spending countercyclically to dampen volatility on a year-to-year or even quarter-to-quarter basis.

Be that as it may, one hopes that GoI continues with this change in the fiscal stance into the next year. The economy will recover in 2021and we expect GDP growth to rise by 13.6%. Admittedly, this is much higher than the current consensus forecast, and it depends quite critically on higher global growth, driven by the expectations of higher US fiscal stimulus, continued strong growth in China, and the worldwide roll-out of the Covid-19 vaccines by H2 2021.

More importantly, it also depends on GoI extending support to the economy. The nearly 20 percentage points turnaround in GDP growth should lead to a strong recovery in government revenue. One hopes — and expects —that GoI does not use all the higher revenue to reduce the deficit. Instead, it should use a substantial part of the increase to raise public spending.

Your Loss is My Profit
But increase spending on what? There are just two areas where GoI should focus: income support and public health. At the risk of sounding like a broken record, despite the expected double-digit growth next year, the level of GDP will still be 4-5% below its pre-pandemic path at end-March 2022. This is akin to losing $200 billion for two straight years. With listed companies managing improving savings by cutting employment and investments (profits of listed companies rose 30% in Q3 2020, according to RBI), the income loss is likely to have fallen disproportionately on households and SMEs. For example, some private surveys point to 18 million job losses so far.

While debt moratorium and other regulatory forbearance have concealed the extent of the damage to household and SME balance sheets, these measures simply postpone the eventual reckoning. The scarring caused by the impairment to balance sheets can seriously reduce medium-term growth, as it has done in previous crises. And if this were to happen, then not only would GoI be forced to spend more to recapitalise banks — and every fiscal indicator that matters to rating agencies and the market, such as medium-term debt sustainability, would ironically worsen — but also banks could turn risk-averse and their reluctance to extend credit could severely hamstring the recovery.

Further, this extended loss of incomes can wreak havoc to income inequality, to poverty, and to the gender gap, as women’s employment is likely to have been disproportionately affected since much of the loss in employment has been borne by services, where female employment is much higher than in manufacturing.

While one understands the clamour for more infrastructure spending, it is surprising that the demand for better public health services hasn’t elicited as much attention even though this crisis was worsened by India’s fragile public health system.

Both Health and Wealth
While cheap skilled labour, India’s large market, the ease of doing business, and policy consistency will remain the key drivers of FDI, it is likely that, after the pandemic, the state of a country’s public health system has become as important a factor.

Investors will look not just for cheap and skilled labour but also a healthy workforce. In the past, the inadequacy of public health was sidestepped, as private services in India were seen as comparable to international standards and much cheaper than in developed countries. Covid-19 showed that private healthcare cannot replace a weak public health system.

Investing in income support and public health are not medium-term issues. They can easily become 2021 problems if not addressed now.

The writer is chief emerging markets economist, JPMorgan. Views are personal