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Economy headed for a high

Economy headed for a high

Silencing the critics of demonetisation and the hasty rollout of the game-changing indirect tax reforms, the Goods and Services Tax, the Narendra Modi government came out with a big ticket public investment this week, particularly in roads, railways and housing, to kick-start the sagging economy, whose growth had dipped to 5.7 per cent of GDP in the first quarter of this financial year.

The big push to pump-prime the economy included a decision to spend a mega 6.9 lakh crore in developing roads across the length and breadth of the country. Whenever the economic growth slows down, the best revival formula is to step up investment in the infrastructure sector. This massive dose of public expenditure will not only boost growth but also create jobs across all parts of the country. This, in turn, will create the much-needed demand.
This will create a multiplier effect in reviving private investment through the much-needed consumption expenditure triggering private investment that has not been forthcoming in the recent quarters due to an excess capacity and the lack of demand.
Armed with strong economic fundamentals including low inflation, current account, and fiscal deficits, the government came out with an unprecedented Rs 2.11 lakh crore recapitalisation package to the ailing public sector banks to boost private investment that has been none too encouraging in the recent quarters, pulling down the economic growth.
The public sector banks have huge surplus liquidity, especially after demonetisation in November last year, with practically the entire Rs 17 lakh crore cash in circulation coming into the banking system. But the banks are not in a position to lend the money because of an excess amount of bad debts. To put life into the ailing public sector banks, this capital infusion is required to enable them to start lending to revive investment, particularly in the private sector, vital for stepping up job creation in the economy. Apart from this "bold and unprecedented" decision to strengthen public sector banks, as Finance Minister Arun Jaitley puts it, the government announced measures to provide funding to medium, small and micro industries, which will be a thrust area of bank lending.
The development of MSMEs is important for job creation as Rs one lakh investment in this sector creates one job as against Rs 6 lakh in capital-intensive large industries. Also, MSMEs accounted for 40 per cent of India's exports and 45 per cent of India's manufacturing. This sector had been badly hit after demonetisation due to a cash crunch and stepping up lending here will help to rejuvenate the sector, which, besides agriculture, forms the backbone of the country's employment and rural economy.
The government will also launch recapitalisation bonds to the tune of Rs 1.35 lakh crore in addition to providing budgetary support of Rs 18,000 crore. This measure was used in the 1990s to help ailing banks when the government embarked upon economic reforms. At that time as well, the banks had huge non-performing assets, requiring large capital infusion to clean up the balance sheets. The remaining Rs 58,000 crore will be raised by banks through a fresh issue of shares while ensuring that the government holding stays above 52 per cent, so as to retain the public sector character of the banks
The fund infusion into various banks will be based on the twin parameters of "performance and potential" where the size of the bank, its ethos and prudence in lending, will be factored in. This meant capital infusion will be subject to comprehensive banking reforms so that indiscriminate lending is not repeated.
According to Arun Jaitley, the Government-owned banks have been hit hard by non-performing assets in the corporate sector due to a lending rush witnessed between 2008 and 2014. "A large part of the indiscriminate lending of the past has turned into NPAs... And, the stressed assets or NPAs were kept below the carpet," the minister said, adding that a large part of the clean-up had been completed so that transparency returned to the banking operations.
The recapitalisation bond details would be worked out with either the government or some designated agencies issuing it to raise funds, which will then be pumped as equity into public sector banks.
Direct borrowing by the government may result in fiscal deficit targets being breached, which the government wants to avoid so that the fiscal consolidation plan remained on track, as in the previous couple of years. An alternative to this will be to get an agency such as the Life Insurance Corporation to issue bonds. The government also has the option to borrow the funds directly and not treat it as a normal borrowing that is added to the fiscal deficit, which is the practice in some other countries.
The fact that the government is not announcing the details in haste indicated that this banking reform measure is done in a manner that is not disruptive to the economic fundamentals, which at the moment are strong, making the country a major destination for foreign direct investment. With the global economy picking up, these measures will help in stepping up Indian's exports as well.
An average 18-20 per cent exports growth will help in giving a push to private investment, thereby subsequently pushing economic growth. With GST in place and exports picking up, coupled with measures to boost infrastructure development, the economy has a potential push growth of at least 2-2.5 percentage points. Coupled with this, with the MSME sector getting back on rails, the economy in all likelihood would get back to a high growth path of 7-7.5 per cent, subject to an early implementation of banking reforms including recapitalisation, in the next few weeks. This is, perhaps, the first major decision after the new Prime Minister's Economic Advisory Council was set up a few weeks back.
In sum, the big investment push in infrastructure and recapitalisation of banks decided by the Union Cabinet recently is providing a much-needed impetus to jump-start the economy, now in a take-off stage after the recent cleaning up operations and transformational tax reforms.
(The views expressed are strictly personal.)

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