Budget 2015: Why government should avoid public spending to speed up the economy

By Ruchir Sharma

India’s economic elite has launched a distracting discussion about new public spending to speed up the economy, despite fresh and glaring evidence that this is a bad idea. Many big emerging nations including China, Russia and Brazil just tried a full-throttle experiment in stimulus spending, and it failed.

The average growth rate for emerging economies excluding China has fallen to 2.5% today, from more than 7% at the height of the spending campaign in 2010. That is the lowest growth rate in four decades, outside of a global recession. For leaders in these countries, stimulus is now a bad word.

Their experiment began in late 2008. As it became clear that falling Western demand was going to undermine growth in emerging economies, these nations embarked on a hurried campaign to fight the looming recession by ramping up public spending. In fact the stimulus campaign launched by emerging economies would dwarf its counterparts in the US and Europe. Among the G-20 – major emerging and developed economies – developed nations spent a sum equal to 4.2% of gross domestic product on stimulus in 2009 and 2010, based on data from the International Labour Organisation (ILO). Emerging ones spent more than half again as much, 6.9% of GDP.

Back then, emerging nations could actually afford to spend more than rich countries, ironically enough. Unlike governments of Europe, those of the emerging world went into the global financial crisis with little public debt, large reserves of foreign currency, and either budget surpluses or small deficits. They had money to burn and they burnt it, producing a brief flare of impressive growth. After bottoming at 3% in 2009, average GDP growth rate in big emerging economies more than doubled in 2010.

True believers in big spending let out a cheer. In 2011, ILO teamed up with European Union and others in lauding the contribution of heavy stimulus spending to a “spectacular” recovery in Asia, and a lesser one in Latin America. Alas, by that point, the flameout was already beginning.

China had ordered up the biggest stimulus – its spending would total 12% of GDP – but since 2010 its growth rate has fallen by a third and it is headed well below 7%. Brazil is in recession. Russia, which spent a staggering 10% of GDP on stimulus, was slowing sharply even before oil prices collapsed.

What happened? Emerging nations borrowed from the future to produce that flash of growth in 2010, and now they face the bills. Their government budgets have fallen into the red, from an aggregate EM surplus of 1% in 2007 to a deficit equal to around 3% of GDP in 2014, while key measures of productivity have declined sharply. Such deterioration helps explain why IMF and others are lowering forecasts for emerging-world GDP growth for the rest of this decade to 4% or less – a return to the pace of the crisis-ridden 1990s.

There is never a good time to rush into big spending programmes, but this is exactly the wrong time for India. The combined government deficit is 6.5% of GDP, one of the highest in the emerging world and government debt as a share of the economy is still at 60%, which is very high for a country with a per capita income of under $2,000.