Raghuram Rajan And Other Celebrity Economists Have Been Proven Wrong

Celebrity economists wanted India to spend billions of rupees to counter Covid-19-related economic difficulties. But the Modi government remained conservative in spending. Who was right?

Context: Countries worldwide are in trouble as their policies to pump money into the economy during the pandemic are now causing woes.

• The UK is nearing inflation of upwards of 20 per cent.

• The US is seeing record inflation and an overall decline in economic productivity.

• Europe, too, is in trouble, exacerbated by the Russia-Ukraine war.

Amid all this, the Indian economy posted significant GDP growth in the first quarter of FY 2022-23. So, what did India do differently?

The answer: Despite relentless calls from economists and experts of repute, India stuck to its strategy of a responsible, graded approach.

• Economists were egging the government on to open the treasury and pump unimaginably large sums into the economy.

• The Modi government rejected these ideas and chose to support the most vulnerable through free rations.

• It was also argued that the resulting economic downturn would be taken care of once the economy reopens.

• The government’s stand, however, was that timing and prevailing circumstances would determine its next move.

The thinking behind the decisions has now been highlighted in an insightful note by former CEA K V Subramanian.

• The impact of macro policy on economic outcomes is felt with a lag.

• Therefore, the government insisted on structural reforms rather than immediate short-term solutions.

• Focusing on policies that increase not just demand but also supply is more economically prudent.

• Demand-side measures alone lead to high inflation in the long term — this is what we’re seeing in the UK, EU, and US.

• This is why India didn’t do huge cash transfers.

Capital expenditure is enormously beneficial for the economy. Since large infra projects are highly capital-intensive and have a long gestation period, it becomes the government’s responsibility to take them up.

• For every Rs 100 spent on revenue expenditure, the government adds Rs 98-99 to the economy. But if it’s capital expenditure, it adds Rs 245 to the economy in the same year.

• Not just that, over the next several years, up to Rs 480 gets added to the economy.

• This explains the Modi government’s focus on infrastructure development via Gati Shakti Yojana, asset monetisation for quicker revenue generation, and the Rs 100 lakh crore infrastructure development plan announced in 2020.

• Private investments collapse during an economic crisis. Therefore, it is incumbent on the government to raise capital expenditure to repump the economy.

How the UPA messed up: During the global financial crisis of 2008-09, the UPA government increased revenue expenditure by 27 per cent, but capital expenditure declined by almost 5 per cent.

• The UPA also did not carry out any structural reforms during this period.

• Be it the MSMEs or the banking system, nothing was reformed with any conviction.

The result was the massive economic downturn India saw after 2011-12.

• This was due to a massive fiscal deficit (due to relentless borrowing and unwise spending), and

• Low capital expenditure led to runaway inflation and a current account deficit.

• Inflation rose from 6.37 per cent in 2007 to 12 per cent in 2012 and 10.9 per cent in 2013.

Bottom line: India’s Covid-19 response drew on tried-and-tested fiscal prudence and a massive push for capital expenditure.

• India also undertook massive structural reforms.

• This, along with other reforms, has largely shielded India from the economic woes the rest of the world is facing.

• India’s targeted spending based on last-mile connectivity was also successful — thanks to Jan Dhan, Aadhaar, and mobile (JAM) connectivity.

• Overall, the political decision to rely on fiscal discipline and ignore calls for going broke in the short run prevented an economic catastrophe from unfolding in India.