What is behind India’s economic slump? Different economists have come up with different answers on this. In a new Economic and Political Weekly research paper, the economist Pulapre Balakrishnan of Ashoka University pins the blame on declining investments and contractionary public policies for the slump.
Balakrishnan argues that both the inflation-targeting regime of the Reserve Bank of India and fiscal policies of the Union government have led to the current situation.
He argues that fiscal consolidation, which involves a targeted reduction in the deficit, is necessarily contractionary, as it lowers output. But at a time of fiscal consolidation, economic policy can lessen its contractionary effect by raising the share of capital expenditure.
In the face of declining private investment, this is what public policy should attempt to do. But the data on the pattern of public expenditure since 2014 shows that the budgetary share of capital first increased to 14.4 percent in 2016-17 from 11.8 in 2014-15 but then sharply fell to 12.3 in the subsequent year. The fiscal space that opened up due to the fall in global oil prices should have been used to expand the capital expenditure but this was not done, he writes.
At the same time, monetary policy was tightened in 2014–15, even though inflation was easing at that time and it continued to be tight excessively long. He also points out that at 2.8%, India’s real interest rate in 2018 was the highest among its Asian peers.
He argues that instead of using one of the two policy instruments in a countervailing way, the conduct of both the monetary and fiscal policies compressed demand.
This miscalculation in policy mix may explain why investments have suffered despite improvement in ease of business rankings, Balakrishnan writes. He argues that macro-economic stability — measured in terms of low fiscal deficit and low inflation — could at times be too much of a good thing.