How big is the shock to the macroeconomy? The gloomy outlook for exports and for prices has reduced the profitability of many investment projects. It is, hence, not unreasonable to think of a reduction in corporate investment from 15% of GDP to 10% of GDP. The macroeconomy may get an adverse shock of roughly 5% of GDP.

In principle, more infrastructure spending could help partly stem the problem. But it is difficult to envisage sufficiently large responses coming about quickly. One of the most successful infrastructure programmes of the government, ever, was the NHDP. This was announced in October 1998, more than a decade ago. It took a long time to get going. In 2006-07, the resources flowing through NHAI were Rs 11,041 crore or roughly 0.2% of GDP.

A grand scale of infrastructure construction is very important for India’s long-term growth, and reasonable bottom-up plans involve spending 50% of GDP on infrastructure construction so as to endow India with a reasonable set of roads, railway lines, airports, pipelines, and urban infrastructure. But getting these projects up and running is slow. If the goal is to achieve short-term macroeconomic stabilisation, countering the business cycle, then infrastructure spending is a poor tool. The most outlandish fantasy would involve doubling the resource flow through NHAI in 2009 when compared with 2008. This would get us from 0.22% of GDP to 0.44% of GDP. This is just not big enough to matter.

This is not to say that this should not be attempted. Every little drop helps. With the fall in prices of steel and cement, and with the reduced prices that will be charged by construction companies, we will get a good bang for the buck. With mature projects such as the Delhi Metro, the NHDP, and the Bombay-Delhi Industrial Corridor, every incremental lever should be utilised to push them to a bigger scale of operation. But the significance of this effort for the macroeconomy is quite limited.

If, in principle, the government were very efficient and actually got a large mass of infrastructure projects rolling, the fiscal constraint will loom large.

The time to fix the roof is when the sun is shining. With buoyant business cycle conditions from 2003 to 2008, this should have been the time to reform tax policy, tax administration, expenditure programs, and achieve fiscal surpluses. If this had been done at that time, it would have been possible to enlarge the fiscal deficit by 2% of GDP in 2009 and make a useful difference to the macroeconomy. Instead, the fiscal deficit of the centre alone for 2008-09 will be 4.7% of GDP. Including the deficit of the states, we would still have one of the worst deficits in the world.

We squandered the opportunity of the 2003-08 upturn. The sun was shining and Parliament was focused on exuberantly spending. These mistakes have real consequences. One reason for being fiscally prudent is to have the space to cope with downturns or other unforseen emergencies. Now a remarkable darkening of the horizon is upon us, and we can only regret the lost opportunities.

In the classic Keynesian argument, there is no fiscal constraint in a ‘liquidity trap’. It is then safe to run large deficits even when they are financed by printing money. However, India is not in a liquidity trap. If India embarks on bigger deficits now, this will lead to higher interest rates for the private sector (since government will make a claim on the finite supply of savings). In addition, credit rating downgrades will increase the cost of foreign borrowing by the private sector.

What counter-cyclical levers, then, does the government control? The most effective levers are those of economic policy reform. There is no short-cut to infrastructure spending. The way forward requires addressing bottlenecks faced in infrastructure financing and against PPP.

The most important bottleneck in infrastructure financing is the lack of the bond-currency-derivatives nexus. The way forward for building this has been mapped out by the Patil, Mistry and Rajan reports. It is possible to push this agenda forward dramatically within weeks.

PPP projects are held back because of policy mistakes in specific areas. As an example, a wave of spending will take place in the economy when 3G telephony is launched. But this requires confronting the ministry of communications. A wave of spending will take place across the cities of India if urban reforms come about, which empower the municipality and establish it as the nerve centre of local government.