Mr FM, cut flab, not muscle. Growth needs more plan spend, bank recap

With the fiscal deficit target for 2014-15 being nearly exhausted by November, the chances are that Arun Jaitley will do another P Chidambaram act, by cutting muscle rather than the fat embedded in government expenditure. As at the end of November 2014, the fiscal deficit had reached 98.9 percent of the year’s budgeted total, which means only drastic cuts in expenditures will enable the finance minister to meet his 4.1 percent fiscal deficit target by 31 March 2015. [caption id=“attachment_1689101” align=“alignleft” width=“380”]  Finance Minister Arun Jaitley. AFP[/caption] As things stand, some low-hanging fruit in terms of non-tax revenues – disinvestment, 2G/3G spectrum auction revenues, etc – might still be available for harvest in the remaining three months of the financial year. But even so, the only way to hit the fiscal deficit target is by cutting plan expenditure – where expenses at the end of November 2014 were at Rs 2,93,651 crore, as against the budgeted Rs 5,75,000 crore. This spending gap of Rs 2,81,349 crore is what must be looking juicy to Jaitley since it will be impossible to spend this much in four months. Plan spending is also easy to cut. However, it is time Jaitley stopped reading from the Chidambaram script of cutting deficits by cutting productive spending. While it may be true that some cuts in plan expenses may be unavoidable, far from hacking what can be spent, Jaitley should in fact try and get ministries to spend as much as possible. This is what will boost growth, as the improved ability of government to spend in the next three months will provide business for India Inc – a kind of pump-priming that will help revive growth by the first quarter of next year, enabling a revival of tax revenues too. Growth in the short run depends on three factors: higher government plan spending, adjusted mostly by cutting non-plan or consumption expenditure; quicker bank reacapitalisation, and raising higher non-tax revenues. The last will probably happen once big-ticket disinvestments like ONGC and Coal India happen this month and the next. But the other two crucial bits – bank recap and plan spending – need a push from the Prime Minister. Simply cutting plan spending to say the fiscal deficit target has been met will mean slowing growth, not reviving it. The real reason why growth isn’t reviving is because India Inc is deeply in debt (read here ), and can’t repay their dues to banks. The banks, in turn, are unable to offer more finance for projects as they have a huge bundle of bad loans in their baskets. So both corporates and banks are on the same page: the former want to cut debt, and the latter are anyway not willing to lend more. When we face a balance-sheet slowdown caused by excess debts and excess bad debts, the answer cannot lie in mindless spending cuts. To break the vicious cycle of low-growth, low investment, high debt, and low lending, the NDA government has to act on all fronts. One, as we noted, is to push up plan spending as much as possible. This will put cash in the hands of industry, which will get business and profits from this spending. It will enable them to repay some of the loans, and resume investing. Two, public sector share sales and spectrum auctions need to be quickened, so that the money comes to the exchequer sooner than later. Three, bank recapitalisation must be fast-forwarded. It is surprising why no nationalised bank has yet come forward to raise more capital from the markets when the government has already allowed them to dilute the government stake to 52 percent. One reason could be that if too many banks bunch their issues together, they will get bad valuations. The quickest way to get around this is for the government to capitalise banks to the tune of Rs 40,000 crore directly. The additional shares issued by the banks can be put into a government-owned special purpose vehicle (SPV), which can then offload these shares to the market at the right time and return the profits to the government. This method would have two advantages: banks would get the capital in one shot so that they can write off bad loans and resume lending quickly; the government would capitalise banks without actually putting in any money (as it has been doing in the past), since banks would issue fresh equity to the government and would get an equivalent amount of government bonds in return. The catch: the fiscal deficit would increase temporarily due to the issue of government bonds to banks. But since the bonds will be repurchased when the SPV-held shares are sold to the public, the fiscal deficit will be self-liquidating in a short time horizon. Mr Jaitley, you must get a move on. Get your banks recapitalised fast.