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Monday, 19 September 2016
How public capex can boost GDP
It can lift India’s medium-term growth potential and add to productivity
There are a number of
reasons why India needs more public capex. The latest growth figures show that
the economic recovery is going through a soft patch — fixed investment growth
continues to fall and with ample spare capacity, high leverage and a weak global
growth outlook, a recovery in private sector investments seems elusive. It is
in this context that all eyes have turned to public capex to fill the void.
The government is aware of the urgency. It has made regulatory modifications to
remove existing bottlenecks, such as the one-time fund infusion into stalled
road projects, the revised hybrid annuity model for roads and easier exit
policies for road developers, among others. Additionally, boosting public
investment in new infrastructure projects is one of its key reform agendas. The
focus is on various sectors, including railways, roads, renewable energy,
inland waterways, ports and smart cities.
In the FY17 Budget, the
Centre announced a 17 per cent increase in public capex, equating to 3.7 per
cent of GDP. The government plans to more than double the pace of road
construction over the next five years, raise rail investment to 5.7 per cent of
GDP over FY16-20 from 2.4 per cent over the last five years, and implement
port-led development projects worth ₹2.45 trillion (1.6 per cent of GDP). The
total planned spending is substantial.
Given the size of the capex requirement, the obvious question is where the
funding will come from. Historically, the majority of public capex has been
funded by public sector units (PSUs), rather than the Centre. For instance, in
FY15, of the 7.4 per cent of GDP in public investment, PSUs contributed 3.2 per
cent and States another 2.6 per cent while the Centre’s was only 1.6 per cent.
Even this year, two-thirds of envisioned infrastructure investment is to be
funded off the Centre’s balance sheet via loans, equity and PSU profits. This
implies that funding capacity critically relies on PSUs, rather than the
The good news here is
that except the telecom and power sectors, where PSUs have high debt levels,
other PSUs like those in the capital goods and infrastructure sectors have
strong balance sheets and negative net debt-to-equity, which indicates that
PSUs have the funding capacity. There are other sources of funding as well. The
railways, for instance, have secured loans from the Life Insurance Corporation
of India against a portfolio of 24 project corridors. Multilateral agencies and
market borrowings are also partly funding the capex plan. As such, funding
should not be a constraint.
More than funding, execution has historically been a bigger challenge. Between
FY08 and FY13, actual capex through internal and extra budgetary resources of
PSUs was on average 17 per cent short of budgeted levels. In April-July FY17,
the Central government has spent only 28.9 per cent of its budgeted capex
compared with 35.6 per cent over the same period in FY16.
That said, the government
did exceed its off-balance sheet capex target in FY16, which itself was 40 per
cent higher than a year ago. Last year, the port sector added 94 million tonnes
of capacity — the most in a single year – suggesting that execution under the
current government is improving. In railways, electrical and civil contracts
awarded for the dedicated freight corridor are around 80 per cent complete.
Data on road construction
and awarding paints a similar story. The pick-up in project-awarding activity
suggests that actual construction should gain traction in the coming quarters.
The economic impact of public capex depends
on its efficiency, the quality of investment projects and the state of private
A 2015 IMF study noted that about 27 per cent of the potential
benefits of public investment in emerging markets are lost due to process
inefficiencies. The government’s recent execution track record, curbs on
corruption and strict timelines suggest that it is focused on improving
The quality of spending is also high. Of the budgeted ₹5.6
trillion in Central government public capex, more than 50 per cent (₹3.1
trillion) is focused on building transportation infrastructure, which should
help reduce logistics costs for private sector manufacturing firms. This could
‘crowd in’, rather than ‘crowd out’ private investment.
According to a 2013 RBI study, public capex (Centre) can have
significant multiplier effects on GDP: 2.1x in the same year, rising to 3.84x
in three years. Using this, we estimate that the budgeted public capex by the
Centre and PSUs could add 0.9 percentage points to FY17 GDP growth. This may
not seem huge given the focus on public capex, but with most of the spending
focused on infrastructure where gestation periods are long, the full benefits
will accrue only over the next two to three years.
In all, a successful launch of public capex would not only drive
near-term growth, but it would also boost India’s medium-term growth potential
by adding to the capital stock and productivity. Hence, even though public
capex is off to a slow start, it is moving in the right direction and will
build a solid foundation for sustainable growth.