India: what is the economic impact of the new stimulus package?
- The Indian government announced a stimulus package which encompasses a USD 35.5bn recapitalisation operation to support the ailing banking sector, as well an USD 108bn investment program in infrastructure
- We expect the package to have limited additional effects on economic growth of 0.2ppts in fiscal year 2018/2019, which can be attributed to higher government investment
- It is a missed opportunity that the package does not contain measures to foster total factor productivity growth, which is determined by e.g. innovative capacity, human capital and institutional quality
Fresh stimulus on the way
On 24 October, finance minister Arun Jaitley announced a two-pillar stimulus package for the Indian economy. The first pillar encompasses a capital injection of INR 2.1tn (USD 35.5bn) over the next two years to support the banking sector in cleaning up its balance sheet. Notably state-owned banks have been suffering from a rising amount of stressed assets (Figure 1). The second pillar consists of plans to invest INR 7tn (USD 108bn) in infrastructure over the next five years, covering 83,000 kilometres of roads.
What is the expected impact of the package?
Although we feel that the recapitalisation operation is positive, it remains questionable whether it will be sufficient, as the total amount of reported NPL’s of INR 7110bn (USD 110bn) is much higher than the announced package. Moreover, we expect that it will take time for loan growth to actually pick up and boost private investment.
Markets have welcomed Modi’s new stimulus package (Figure 2). Moreover, yields remained stable, which indicates that markets do not expect a significant deterioration of fiscal government metrics. Missing the deficit target, set at -3.2% of GDP in fiscal year 2017/2018, could result in higher inflation and weigh on growth. Apparently, Jaitley succeeded in reassuring the market that the stimulus package would not result in a missed fiscal deficit target. This is mainly due to the way of financing of both the recapitalisation operation, as well as the infrastructural projects. Around 60% (INR 1350bn) of the capital injection will be financed by recapitalisation bonds and the remainder will be covered by earlier budgetary commitments and share issues by banks. Details on these recapitalisation bonds, however, have not been revealed yet, but according to IMF guidelines, these types of bonds can be used as off-balance sheet vehicles. This explains why the issuance of these bonds will not affect the fiscal deficit. The bulk of the USD 110bn infrastructural investment will be funded by toll collections in the past and by the private sector. The contribution by the government will be somewhere around USD 40bn spread over five years. Our assessment is that this won’t affect fiscal metrics too much. The government’s fiscal position has been gradually improving (Figure 3). Moreover, demonetisation and GST will foster future government tax revenue. In October 2017, annual net tax revenues were already 13% higher compared the same period last year (Figure 4).
But don’t copy China…
The policy direction of the Indian government resembles measures taken by that other big emerging market: China. In response to the global financial meltdown, the Chinese government launched a large stimulus program in order to prop up debt-loaded investment in real estate and infrastructure.
Although this helped to mitigate the negative effects of the crisis in 2009, the Chinese government currently is struggling to scale down its massive corporate and local debt burden and to restructure inefficiently allocated capital and labour. India should be wary to prop up investment top down too heavily, as the economy might get addicted to investment which don’t have any guarantee of repaying themselves. And although we underline the fact that a solid infrastructure is a condition sine qua non for an attractive business climate, it is a missed opportunity that the announced stimulus package of the Indian government is not putting more emphasis on fostering so-called total factor productivity (TFP) growth, which is determined by innovative capacity, proper education and training of the work force and improvement of institutions. Ultimately, TFP will determine whether India will be able to avert the so-called middle income trap (see Figure 5, Erken, 2017). Compared to other countries, India ranks position 130 in terms of ease of doing business, has an average of 0,3 years of tertiary education of the population aged 25 years and older (vis-à-vis for instance 0,6 years in Mexico and 1,5 years in South Korea) and its innovation system only generates 2 USPTO patents per 100,000 workers (vis-à-vis 500 unique inventions in, e.g., Japan).
Minor implications for our outlook
All in all, we expect the infrastructural projects to boost government investment in the medium to longer term, and consequently have a knock on effect on growth of 0.2ppts in FY2018/2019. This additional growth is directly related to higher government investment (Table 1). Perhaps private investment will be impacted positively in the medium to longer term on the back of the entire stimulus package. Anecdotal evidence from our ‘ears and eyes on the ground’ indeed suggests that markets are actively looking at increasing capacity. However, we do not choose to alter our forecast on private investment growth, given the risk of crowding-out of private investment by public investment. Moreover, we were already quite bullish in our growth expectation of private fixed capital formation, despite a current capex gridlock.