Such an approach has a higher multiplier effect on growth, noted IMF
Countries such as India with limited fiscal space can rely on debt financing to boost public investment in the short-to-medium term, to revive the covid pandemic-hit economy, the International Monetary Fund (IMF) said in a report. Such an approach has a higher multiplier effect on growth than infrastructure financed through tax, it said.
IMF analysed infrastructure financing through growth-debt trade-off in emerging and developing Asian countries, in the report titled Well Spent: How Strong Infrastructure Governance Can End Waste in Public Investment.
contracted 23.9% in the June quarter as a result of a double whammy of demand contraction and supply shock following the countrywide lockdown. The path to recovery has been slow with a rapid rise in coronavirus cases.
Most forecasters expect Asia’s third largest economy to experience a double-digit contraction in FY21 before making a sharp recovery in FY22 because of a lower base. The government has announced a fiscal stimulus of 1.2% of GDP, but falling revenue collections have limited its ability to commit higher public expenditure for social and physical infrastructure.
Policymakers who consider building infrastructure stock need to look at potential macro-economic and fiscal consequences, the authors hold in the chapter titled ‘Boosting Infrastructure in Emerging Asia’. “Boosting spending on infrastructure can raise growth in the short term by stimulating aggregate demand. It can also shore up potential growth in the long term as better infrastructure promotes the economy’s productivity. Nonetheless, the spending boost can result in higher fiscal deficits and public debt if financed by borrowing, which can also crowd out private investment. Alternatively, a tax-financed spending boost can prevent increasing public debt, but the growth stimulus can be dampened by higher taxes on domestic demand or labour supply," they say.
The study undertaken for six Asian economies, including India, Indonesia, Philippines, Thailand, Vietnam, and Sri Lanka, looked at various scenarios of infra financing and its impact on growth.
The study concludes that in emerging and developing Asia, including India, financing an infrastructure spending boost with higher indirect taxes would be desirable in the long term in view of a growth-debt trade-off. However, in the short-to-medium term, assuming a benign borrowing risk premium, the growth pickup would generally be higher with debt financing rather than tax financing.
“Among tax options to finance the spending boost, indirect taxes such as value added tax (VAT) are less distortive and generate more growth than income taxes. While VAT financing would be a preferable option for policymakers for the long term, they would need to be mindful of its negative impact on income inequality, which can be dealt with by strengthening public spending that brings relative strong benefits to the poor, such as education, health care, and targeted social safety nets," it says.
The covid-19 pandemic and its economic fallout is still unfolding, and creating good infrastructure through strong infrastructure governance is more important than ever and key to supporting economic recovery, says Kristalina Georgieva, managing director, IMF.
“Across countries, discussions on infrastructure, the what, why, where, and how much, are closely linked to the sustainable development goals, which call for significantly scaling up infrastructure in areas such as health, water, sanitation, energy, and transportation, as well as adapting and fostering resilience to climate change. The economic recovery from the covid-19 pandemic will require strong infrastructure governance to ensure that investment spending contributes to high-quality economic growth," she says.