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Due to poor recent experiences with the private sector, the government is pushing for much higher public investment, especially in infrastructure – at the cost of fiscal prudence
In the Mid-Year Economic Analysis (MYEA) for 2014-15, the Indian government has called a major policy change -- more public investment, especially in infrastructure segment. Tucked away on page 18 and 21, it says, "To revive growth, public investment may have to play a greater role … Consideration should be given to pursuing counter-structural fiscal policy as a way of reviving growth, and to finding the fiscal space to finance such investment…"
However, the question, especially looking at past experience, is whether public investment will necessarily lead to efficient outcomes. In addition, what will be the implication on fiscal deficit and interest rates? This concern is on the backburner for now.
The government is turning impatient about poor growth and wants to take the reins of investment-led growth in its hands. According to the Mid-Year Review, the case in India for public investment going forward is threefold. "First, there may well be projects like roads, public irrigation, and basic connectivity, that the private sector might be hesitant to embrace. Second, the lesson from the Public Private Partnership experience is that given India's weak institutions there are serious costs to requiring the private sector taking on project implementation risks: delays in land acquisition and environmental clearances, and variability of input supplies, all of which have led to stalled projects.
These are more effectively handled by the public sector. Third, the pressing constraint on manufacturing is infrastructure. Power supply and connectivity are key inputs that determine the competitiveness of manufacturing."
How will this ambitious intervention be financed? The report notes "India has a fiscal flow problem but not a stock problem because the ratio of Government debt to GDP has declined substantially over the last decade due to a combination of high growth and high inflation," the report said. The report also notes, “that the debt dynamics will continue to work in India's favour as long as growth remains around 6% and the primary deficit remains in the current range of 1% of GDP. A case not just for counter-cyclical but counter-structural fiscal policy, motivated by reviving medium-term investment and growth, may need to be actively considered.”
This means the government thinks it has a lot of room to borrow. In overall terms, what the government in effect in the report is saying that, India desperately needs investment in infrastructure. The government will step in to boost it and it does not care much about slippage in fiscal deficit target in the process.
The push by public sector comes in the wake of disappointment of the last few years following “over-exuberant investment, especially in the infrastructure and in the form of PPPs”. There are stalled projects to the tune of Rs18 lakh crore (or about 13% of GDP) of which an estimated 60% are in infrastructure. In turn, this reflects low and declining corporate profitability as more than one-third firms have an interest coverage ratio of less than one, as borrowing is used to cover interest payments. Over-indebtedness in the corporate sector with median debt-equity ratios at 70% is amongst the highest in the world. The ripples from the corporate sector have extended to the banking sector where restructured assets are estimated at about 11-12% of total assets. Displaying risk aversion, the banking sector is increasingly unable and unwilling to lend to the real sector, it added.
Laying the ground for public expenditure to get out of this quagmire, the report argues that attracting new private investment, especially in infrastructure, in this climate, will be tough. "The PPP model has been less than successful. The key underlying problem of allocating the burden from the past, the stock problem that afflicts corporate and banks' balance sheets needs to be resolved sooner rather than later. The uncertainty and appetite for repeating this experience is open to question," the report said.
The other reason to argue for public expenditure is that while “private corporate investment surged in the boom phase, public investment too grew by about 3 percentage points. In addition, just as corporate investment declined by 8 percentage points during 2007-08 to 2013-14, so too has public investment by about 1.5 percentage points.”
If the thought process contained in the report is implemented, the bottomline would be this- The government and various public sector arms will enter the debt market to borrow massively. This demand for money will keep actual interest rates high, even if the Reserve Bank of India (RBI) cuts interest rates. Even that would be acceptable but what about the quality and deadline of public projects? The report notes, "To be sure, a greater role for the public sector will risk foregoing the efficiency gains from private sector participation. A balance may need to be struck with targeted public investments, carefully identified and closely monitored, by public institutions with a modicum of proven capacity for efficiency, and confined to sectors with the greatest positive spill-overs for the rest of the economy. These may then be able to crowd in greater private investment".
Given how poorly supervised public investments are, this is a pipedream. All we may get out of this adventure is fiscal slippage.