If the economy were a human body then finance would be its lifeblood. As long as it continues to flow through the veins efficiently the body remains healthy. But what happens when it doesn’t? The body can die.

No wonder then that in this time of pandemic, central banks around the world have sought to pump liquidity into their financial sector to save their economies from collapse. The RBI has done nothing different. Since March 24, when Prime Minister Narendra Modi announced a 21-day nationwide lockdown, it has released up to Rs 3.74 trillion ($50 billion) in the banking sector.

That action may have averted an imminent disaster. Indian public sector banks were already struggling with the problem of non-performing assets. The pandemic could only have made it worse. Recapitalising the banking sector was therefore a step in the right direction. Now as India shifts from the emergency phase to the recovery phase it needs to consider its policy options carefully, as the economic outlook doesn’t look good.

Covid-19 has come as a supply as well as demand shock resulting in the contraction of the economy. The private sector is no longer optimistic about the future and is unlikely to make long term investments. The price of gold is at an all-time high indicating that private capital is rushing for safety. The onus to stimulate the economy, therefore, falls on the government. One way to do that is to spend on infrastructure. Without a concerted effort to restart large upstream projects, it may be difficult to reboot the economy.

Public investment in infrastructure has a positive spillover effect. According to the McKinsey Global Institute, every dollar invested in infrastructure can get upto 20 cents more in economic returns. For infrastructure deficient countries like India, such a return will almost certainly be higher.

There is some historic precedence for this. During the Great Depression that followed the great stock market crash of 1929, President Franklin Roosevelt launched a series of public works projects that put thousands to work and pulled the US out of the economic slump. The most iconic among these was the 726-feet-high Hoover Dam. Roosevelt’s New Deal modernised America’s infrastructure, created millions of new jobs and most importantly, infused a sense of optimism that prepared the US to enter World War II as a formidable power.

Could such an experiment work for India? Well, not if there is no room to finance it. To become a $5 trillion economy by 2025, India needs to spend a whopping $1.4 trillion on infrastructure. But where will all that money come from?

For now, the focus appears to be on mobilising resources at home. In May, the Indian government put Rs 300 billion worth of high yield bonds on the domestic market. But they were mostly bought by state-run banks and financial institutions. Now here is the problem. The more money banks lend to the government the less there is to extend as credit to the private sector. That leaves small and medium sized borrowers high and dry.

India’s public sector borrowing amounts to as much as 8.5% of GDP and rising. This isn’t healthy. Banks need to be adequately capitalised to meet the bill for recovery. Even if economic activity returns to normal tax revenues will fall short of the target for some time to come. Selling stakes in public sector units may also not generate as much revenue as previously expected. India’s fiscal deficit-to-GDP ratio was already stretched even before the pandemic struck.

S&P Global predicts India’s fiscal deficit could be as much as 11% of the GDP by 2021. Simply monetising the debt by printing more money is no answer. What the government may need to do now is to look outside. India’s external debt is merely 3.5% of the GDP – among the lowest in the world. It can afford to borrow more.

For a start, consider lifting the limits set on foreign investors in the debt market. At the moment, FIIs can hold no more than 30% of their total investment as debt. That’s a pity. International banks and institutional investors are estimated to have $120 trillion in assets under management. Even if India can tap a small proportion of this money it would go a long way in meeting its requirement. Moreover, global interest rates are at historical lows. Borrowing in dollars therefore may not be as difficult to service as some believe.

Another big hurdle is the absence of a long pipeline of bankable projects. India needs more technical assistance to crack this problem. It can also take advantage of concessionary finance facilities extended by international development finance institutions (DFIs). The World Bank, IMF and ADB are providing generous financial assistance to member countries facing Covid-19. In April, the World Bank approved a fast-track $1 billion in emergency financial package to help India respond to the pandemic. Two months later it approved $750 million to support the flow of finance for MSMEs.

Since large infrastructure projects are usually carried out on a PPP model, risk sharing becomes extremely important. This is where development finance can come in. By taking on first loss and extending credit risk guarantee it can catalyse long term private sector investment. Infrastructure projects often take years to break even and need sustainable long term financing. India’s financial system simply does not have the liquidity to provide it all on its own. Squeezing it further will not help. India must find the money elsewhere.

DISCLAIMER : Views expressed above are the author’s own.


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