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Context:

The government should prioritize increasing revenue expenditure to stimulate consumption, income growth, and private investment.

Details

The Indian economy is going through a rough patch as was evident from the recently released provisional estimates of its Gross Domestic Product (GDP). The expected growth rate is lower than what was expected and estimated by the government earlier. 

Why is the Indian economy facing a slowdown?

Major disruptions like demonetization (2016), the introduction of GST (2017), and COVID-19 lockdowns (2020-2021) have severely impacted economic activity, particularly in the informal sector and small businesses.

Private investment has not responded to government efforts, such as tax cuts and increased capex. Firms are hesitant to invest due to low demand and underutilized capacity.

The government’s focus on capital-intensive projects (e.g., dams, nuclear plants) has limited multiplier effects.  

While capex has increased, overall fiscal expenditure as a percentage of GDP has fallen, limiting the government’s ability to stimulate demand.

What has the government done so far to address the slowdown?

The government has focused on capital-intensive projects like infrastructure development, expecting it to crowd in private investment.

Corporate tax rates were reduced from 30% to 22% in 2019 to encourage private investment.

Despite rising capex, overall fiscal expenditure as a percentage of GDP has declined, reducing the government’s ability to stimulate demand.

Private investment has not picked up due to low demand and underutilized capacity, rendering tax cuts and capex ineffective.

What should the government do to reverse the slowdown?

The government should raise overall fiscal spending to stimulate demand and economic activity.

Prioritize revenue expenditure, particularly in the social sector, to boost incomes and consumption among lower-income groups.

Capital expenditure should focus on labour-intensive projects with higher employment multipliers, such as rural infrastructure and small-scale industries.

Expand programs like NREGA and introduce new schemes to provide income support and employment to vulnerable populations.

Increase investment in agriculture and rural development to raise rural incomes and stimulate demand for mass consumption goods.

Ensure fiscal measures are complemented by accommodative monetary policies, such as lower interest rates, to encourage borrowing and investment.

Implement long-term reforms in education, skill development, and infrastructure to enhance productivity and economic resilience.

While increasing spending, ensure fiscal responsibility to avoid unsustainable debt levels and maintain economic stability.

Why is private investment not picking up despite government efforts?

Private investment responds to demand conditions. With sluggish private consumption, firms are hesitant to invest even if they have access to cheap credit or post-tax profits.

Existing factories and businesses are operating below capacity, reducing the need for additional investment.

Economic shocks like demonetization, GST, and COVID-19 have created uncertainty, discouraging private investment.

The government’s focus on capital-intensive projects has not generated sufficient demand to incentivize private investment.

What lessons can be learned from the 2004-2011 period?

The government introduced rights-based legislations like the National Rural Employment Guarantee Act (NREGA), which provided jobs and income to rural workers, boosting consumption among lower-income groups.

The share of social services and developmental expenditures rose significantly during this period. Spending on education, health, and rural development directly improved incomes and living standards for the bottom 80% of the population.

NREGA and other rural development programs set a floor for rural wages, increasing incomes for casual and unskilled workers. This led to higher consumption of mass consumption goods.

Lower-income groups, who benefited from state interventions, have a higher propensity to consume. This increased demand for goods and services, driving economic growth.

The share of consumption by the richest 20% declined, while the bottom 80% saw faster consumption growth. This unique trend was driven by state policies that prioritized welfare and income redistribution.

Increased spending on agriculture and rural development contributed to higher rural incomes, further boosting consumption and reducing poverty.

How can the Budget arrest growth decline?

The budget can boost economic activity by increasing spending on infrastructure, public services, and social programs. This will create jobs and raise demand, which will help to reverse the slowdown.

Reducing taxes for individuals and businesses increases disposable income, encouraging spending and investment. For example, income tax cuts can boost consumer demand and business expansion.

The budget can propose subsidies, grants, and financial aid to struggling sectors like agriculture and small businesses.  

Increasing spending on social sectors like health, education, and welfare can boost incomes for lower-income groups, which will create a multiplier effect, boosting demand and economic activity.

Capital expenditure should prioritize labour-intensive projects with higher employment multipliers, such as rural development and small-scale infrastructure, to maximize job creation and income generation.

While fiscal policy drives the budget, coordination with monetary policy (e.g., lowering interest rates) can enhance economic stabilization efforts by reducing borrowing costs and encouraging investment.

The budget can outline reforms in education, skill development, and infrastructure to improve productivity and long-term economic resilience.

While stimulating the economy, the budget must ensure fiscal discipline to avoid unsustainable debt levels. This involves balancing expenditures and revenues and managing national debt effectively.

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Source: 

THE HINDU