Bhagwati is right. Modi's spending boost may irk investors and risk rating downgrade

A weak recovery from the longest growth slowdown in decades is pushing Prime Minister Narendra Modi’s advisers to consider loosening fiscal deficit targets and increase government spending, thereby risking the ire of investors, ratings agencies and the central bank. Ahead of the budget in February, Modi’s new team of advisers has argued for higher deficits to fund infrastructure projects needed to remove bottlenecks constraining growth and to create jobs for a burgeoning workforce. Yet with debt service devouring 42 percent of government spending, higher deficits would revive risks of a ratings downgrade and delay an interest rate cut by the Reserve Bank of India (RBI). As Jagdish Bhagwati, professor of economics, law and international affairs at Columbia University, rightly said in an interview with the Hindustan Times, the Narendra Modi government has got the sequencing of reforms right, but it should not start spending money until revenues start flowing in. Bhagwati’s logic is that only by generating sufficient growth  would there be enough wealth to spread around which is why his most urgent policy prescription  is to slow government spending, which he blames for high inflation. [caption id=“attachment_529146” align=“alignleft” width=“380”]  Jagdish Bhagwati. Moneycontrol.com[/caption] " UPA 2 government’s major problem was that they had converted a lot of expenditure into social rights and obligations that were enforceable even by the courts. On other hand, growth had slowed down because, among others, of all the corruption charges. Given the fact that he (Modi) wants to spend the money on infrastructure and others, he has to worry about finance minister Arun Jaitley producing the money. The PM can develop the ideas, put things in place, but he should not start spending the money until he begins to get it in a big way," Jagdish Bhagwati told Hindustan Times. Economist Arvind Panagariya, named last week by Modi to run his new policy unit, has  in the past too acknowledged that Prime Minisiter Narendra Modi understands the folly of embracing substantial spending programmess that outpace revenues. In October last year, Panagriya along with Bhagwati had in a Times of India blog post argued that streamlining existing  social welfare schemes as also replacing them by new ones are essential steps towards garnering  resources to step up government expenditure . “While increased revenues will follow as the economy picks up, there are inevitable time lags. So some programmes have to be pruned here and now,” the blog post had said.  Weak investment has been a prime cause of India’s worst economic performance in a quarter century, with two successive years of sub-5 percent growth before a weak recovery began during 2014/15. To make good on that pledge, Modi plans to spend up to $50 billion in the year to March 2016 on new roads, rail lines, ports and irrigation facilities. “The most urgent priority (is) to build the productive capacity of the economy and launch a supply-side revolution,” said Jayant Sinha, a deputy finance minister, adding that India needs growth rates of 7-8 percent to prosper. But this strategy could mean ditching targets to trim the fiscal deficit to an eight-year low of 3.6 percent of GDP in 2015/16 and 3 percent the following year. With a national debt at 70 percent of GDP and a consolidated fiscal deficit above 7 percent, India’s public finances are worse than its peers and it has spent recent years at risk of a downgrade of its sovereign credit rating to ‘junk’ status. Success in narrowing the deficit by 1.2 percentage points to 4.5 percent last year helped ward off downgrades. Keeping India at the lowest investment grade rating, major rating agencies have urged the central government to invest more without increasing borrowing. With inputs from Reuters