Don’t Panic

THESE ARE DAYS OF GLOOM and doom in India. Not a day passes before another dire economic prediction is made with unusual gusto. From faltering growth numbers to job losses in the textiles, gems and jewellery, handicrafts and other sectors, it seems India is doing nothing right. Much of the anxiety on display is of recent origin, dating to the end of August when the first round of GDP growth data for 2017-18 was posted by the Central Statistics Office. Even before the numbers had been crunched, conclusions began to arrive: demonetisation was to blame for the misery of poor Indians and finally there was proof that the Narendra Modi Government had mismanaged the economy. The fury has not abated since.

Such has been the intensity of criticism, that the Prime Minister himself decided to counter detractors who said the Indian economy was in a ‘tailspin’. On October 4th, he admitted that quarterly data had shown an economic contraction. But he added that the Government had the capacity to change things for the better. He lashed out at critics for spreading despair. As a leader, he knows the importance of expectations in a modern economy and how negative sentiments can hurt the actual economy. His quick rebuttal was meant to forestall any negative impact.

Some of the figures are indeed a cause for worry. In the first three months of the fiscal year 2017-18, the rate of economic growth slowed to 5.7 per cent, while the figure for the same period in the previous year was 7.9 per cent. This represents a fall of 2.2 percentage points. More significantly, investment as a proportion of Gross Domestic Product (GDP)—perhaps the most important propellor of overall growth—came in at only 29.9 per cent, which is below the psychological level of 30 per cent.

While this was a figure for a single quarter and not the full year, it was sufficient for prophecies of doom. No clarifications offered by the Government, economists of different persuasions or a closer look at the data could contain critics of a particular kind who see nothing positive in this Government.

The cumulative effect of a decline in growth, a pile of anecdotal evidence on the disruptions of demonetisation and teething problems of the Goods and Services Tax (GST) has been negative on the general mood in many circles. Long accustomed to 7 per cent growth quarter after quarter and year after year, almost taking it for granted, a number of Indians—especially analysts and some policymakers—have been spooked by India’s ‘poor growth number’. To add to these fears, the ruling BJP’s own ‘internal opposition’, led most notably by former Finance Minister Yashwant Sinha, has chosen to mix economic fire with political brimstone. In a scathing opinion piece that appeared in The Indian Express late last month, Sinha lays heavy blame at the door of the Government for what he counts as policy mistakes such as ‘frittering away the oil bonanza’ and not acting fast enough to handle other problems such as the high level of Non-Performing Assets (NPAs) in the banking sector. Sinha also pins India’s current economic woes on demonetisation and a badly designed GST.

In the time since the quarterly figures were released on August 31st, voices have grown louder for the Government to use a fiscal stimulus programme as part of an exercise to spur growth. While low by contemporary Indian performance standards, a rate of 5.7 per cent cannot be dubbed a disaster. While anything under 7 per cent is below what is needed to make a difference in terms of jobs and incomes, it warrants neither the panic on display nor the emergency measures being suggested.

A fiscal stimulus can take many forms. For example, the Government can increase its spending on goods and services, which, in turn, would increase money in the hands of people and thus boost growth by encouraging consumption. Another form could be a reduction in taxes to increase disposable income in the hands of consumers, which again has the potential of raising the quantum of money going around, spelling increased employment. Or it could be a combination of all these. The last time a ‘big stimulus’ of this kind was imparted to the Indian economy was in 2008, in the wake of the global economic crisis.

Late on October 3rd, the Government cut excise duties on petroleum products, thus providing some relief to consumers. But this step came just days after aviation fuel prices and those of LPG were raised, a demonstration of caution on the Government’s part.

As matters stand now, there is a weak case for a stimulus that would involve higher government spending or a reduction in taxes—direct or indirect. For one, there is no room for extra expenditure. In the Union Budget for 2017-18, the Government had set itself a fiscal deficit target of 3.2 per cent of GDP. Government accounts show that by the end of August, the gap between total expenditure and gross revenue—the fiscal deficit—had touched 96.1 per cent of the budgeted amount. The corresponding figure for the same period last year, 2016-17, was 76.4 per cent. This means there has been slippage in performance this year. Unless the target is given up, it is not clear where the money for a stimulus will come from. There is, of course, an even more basic question: how will a stimulus help? The core problem of the economy, as highlighted above, is a weakness in investment. This has been a headache now for many years. In the absence of it, excess spending will only lead to frittering away of money. In fact, a stimulus at this stage will create even more problems than provide a solution.

In the wake of GST and demonetisation, supply chains in various sectors have severely been disrupted. In such a situation, a loosening of the state’s purse strings could result in more imports than domestic production. Apart from increasing the fiscal deficit, this will cause external imbalances. As it is, imports have galloped in the first quarter and have been blamed for the slowdown.

Breaching the fiscal deficit target will also complicate efforts to lower the cost of capital for businesses. The Reserve Bank of India (RBI) keeps a close watch on government expenditure and its deficit control while setting its policy rate of interest. Historically, the central bank has shied away from reducing rates if state expenditure has risen above the budgetary target. At the moment, of course, inflation is under check and there has been a historic decline in prices of agricultural commodities. But a fiscal stimulus at this juncture might throw this calculus into disarray.

There is, however, a contrarian opinion on the need to inject the economy with money, one that is based on making the right investment decisions. “I think a case for a stimulus is inescapable. We have had two policy-engineered recessionary shocks [by way of] money supply and tax rates on economic activity,” says Maitreesh Ghatak, a professor of economics at the London School of Economics and a keen observer of the Indian economy. “Of the various options,” he says, “public investment in infrastructure is the obvious one, given the employment it will generate on top of creating purchasing power in the hands of a much broader base of consumers than the middle-class, other than the long-term gains as well as equity considerations for a segment of the economy that has been most badly hit and has a high fraction of the poor.”

So what is to be done? There is probably not much the Government can do at the moment. The core problem—of low investment— requires a different fix, one that has been applied. If there is a legitimate criticism levelled against this government, it is that it recognised the gravity of this a little late. Sustainable growth requires that both consumption and investment demand keep pace with each other. In recent years, the former has been robust while the latter has sputtered. The reasons are not far to seek. Indian companies, especially those in infrastructure, borrowed heavily in the past decade. At the same time, banks lent loads of money to sectors such as power and iron and steel, among others. This was inherently a risky proposition. According to recent data from the Centre for Monitoring Indian Economy (CMIE), the number of stalled projects in the country this year has risen to its highest level in the past 13 years. Of these, two-thirds are private and most of these are in the power sector.

The result is a huge overhang in the banking system. On one hand, the level of NPAs has risen to an unprecedented 12 per cent for Public Sector Banks (PSBs), and on the other, private companies are reluctant to borrow more as they are saddled with previous loans. Unless this tangle of bad loans is unwound, corporate investment is unlikely to pick up. There is fear that NPAs in PSBs may even go as high as 14 per cent by the end of March 2018.

A big attempt to resolve that crisis has already been made. Last May, the Insolvency and Bankruptcy Code (IBC) finally came into force after years of planning, drafting and legislative scrutiny. Under this law—which creates a unified framework for resolving the kind of problems faced by a combination of bad loans and companies unable to pay them back—the first order was passed by the National Company Law Tribunal this August. This, however, is just the beginning of a slow and painful unwinding.

So, are charges that the Government has been slow in addressing NPAs valid? “The Government had to be careful in drawing up the Code, and scrutiny takes time,” says Vivek Dehejia, a professor of economics at Carleton University in Canada.

For any government in India, the tough part of economic policymaking is to link day-to-day macroeconomic management with a longer-term coherence. It is one thing to ensure that a crisis does not hit India, but an altogether different challenge to put the country on a trajectory of rapid expansion, which is essential to reduce poverty and even tackle inequality. Here, a variety of views have been put forth on how the Government has performed. Opinion is divided between those who say that implementation and short-run management has been wanting, even if its long-run policies pan out well. The obverse opinion also draws on facts.

In a recent article, the economists Ajit Ranade and Soumya Kanti Ghosh echo the first claim, arguing that, ‘Structural and deep reforms like the GST, Real Estate (Regulation and Development) Act, monetary policy framework and move to a cashless economy will all pay over the longer term. However, they have created short-term uncertainties and disruption. This needs deft policy and perception management.’ In contrast, Ghatak says, “It will be an interesting thought experiment to see what would be the reactions to GST implementation and demonetisation under a Congress government. I think the criticism would have been far more severe.”

The issue is not just about perceptions—and their management— even if this is an important aspect of a functional democratic system. The question that confronts any elected government is how to go about achieving higher growth when it demands tough and painful decisions? When the Modi Government assumed power in mid-2014, the near consensus among non- leftist economists in the country was that badly jammed factor markets—land and labour, in particular—could thwart India’s chances. Back then, a few voices held that India’s ‘demographic dividend’ had the potential of turning into a nightmare if these markets were left unreformed. The targets for reform were the 2013 land law that made it almost impossible to acquire land for a ‘public purpose’ and antiquated labour laws—some going back to the colonial period—which sustained a labour aristocracy. To be fair to the Modi Government, it tried hard to undo some of these in its first year of power. Despite the NDA’s lack of a Rajya Sabha majority, it issued and re-issued an ordinance to modify the land acquisition law, for instance, before it eventually gave up. The political cost of undoing that law rose even as the path got blocked. Also, by mid-2015, it was clear that the banking mess was a far bigger problem, and priorities changed. As a result, factor market reforms remain the unfinished legacy of what was begun in 1991, when India adopted market principles to boost its economy.

IT IS NOT as if the current Government has done little by way of impactful reforms. It has chosen an alternative path to shift the economy’s gears, making some drastic and wide-ranging changes. If one connects the dots from the abolition of the Planning Commission on August 17th, 2014, to the implementation of the GST on July 1st, a clear pattern emerges.

If reforming land and labour laws is one way to push growth, there is another—somewhat different—path that was available, but one that defies the crisp descriptor of ‘reforms’. In two-and- half decades after the liberalisation of 1991, India had acquired a new set of vested economic interests. As growth became part of the landscape, so did corruption. This was a byproduct of the gap between goods and services demanded from the Government and what it was able to deliver. Rampant evasion of taxes, the prosperity of ‘invisible enterprises’ below the state’s radar and a huge informal economy ensured that India’s would remain a sclerotic economy. Economists like the late Mancur Olson described this as the proliferation of distributional coalitions that leave little surplus in the hands of the government to invest for productive ends. If the lack of land and labour reforms pin India down, this is the other side of the equation.

What Modi has done in the last three years is to engage in ‘Olsonian destruction’ of a kind not seen in India before. Demonetisation and GST are part of this shedding of distributional coalitions. For example, the GST has allegedly upset a large section of the BJP’s so-called original constituents. These were people whose businesses rarely paid their indirect tax dues. The noise over the tax’s ‘poor implementation’ is actually code language within a group that now has to cough up what it legitimately must. It is early days yet, but if the Government ends up with a sizeable accretion to its kitty, not only will it be able to spend more on welfare schemes, but also have enough to invest in badly-needed infrastructure. The outcome of Modi’s approach will be known soon.

The exercise is not painless. Both GST and demonetisation have led to severe criticism of the Government and the two have not been easy to implement. But, compared to the stalled economic reforms, these have come about with relative ease. Why? “Why indeed is it harder to reform factor markets but relatively easy to pull of demo/GST, at least politically? The answer must lie in the seeming universality—everyone’s inconvenienced. With factor market reforms, it’s always, ‘Why us and why not that group?’ Also, these reforms are less transparent in terms of the incidence of their costs and benefits,” says Ghatak.

India is almost unique among democratic countries in this respect. Unlike mature democracies where there are countervailing institutions that shield economic policymaking from the impact of competitive politics, India virtually has no such institutions. The ones that are designed to keep the political heat away—some economic regulators come to mind—have also come under pressure at times. As a polity, India has perfected the art of arbitrage: no sooner does an opportunity present itself than the political system closes it, with almost every participant rushing in for quick gains. It is another matter that this greatly competitive political system is destructive to the country’s economic potential.

Arun Jaitleyeconomic reformsGDP growthGSTIndian economyNarendra Modipanic