Stoking Recession Fears

A real growth rate of 5 per cent in the first quarter of 2019-2020 followed by a growth of 4.5 per cent in the second quarter means an average of 4.75 per cent for the half year. The second half of the year should be better. But even then, for the entire year, real growth will be around 5 per cent. That’s still growth. Those who use expressions like ‘recession’ forget that it means negative growth: a decline in gross domestic product (GDP) typically over at least two quarters. (For example, Mexico now has a recession.) Nominal growth is real growth plus inflation. With an inflation rate of around 3 per cent, nominal growth will be 8 per cent. That, in turn, means an average corporate profitability of 12 per cent. This doesn’t quite sound like gloom and doom, does it? A macroeconomic success of the Government since 2014 has been containment of inflation—this is not appreciated enough. (Inflation hurts the poor more. It is regressive.) Would we have been better off with a real growth of 5 per cent, inflation of 10 per cent and nominal growth of 15 per cent? (It would certainly have been better for Government revenues.) But yes, if not recession, there has been a downturn. (Given the state of the world economy, it is not as if other countries haven’t suffered downturns.) No one argues 5 per cent is enough. Indeed, growth rates should be higher.

India is not an insulated economy. The export-GDP ratio is almost 20 per cent. There were high growth years when India clocked a rate of 9 per cent. In those years, India’s exports grew at rates in excess of 15 per cent. (Growth rates depend on whether one uses dollar or rupee figures.) Therefore, at least 3 per cent of GDP growth was due to exports. If export growth peters out, we are down to 6 per cent GDP growth rates. What determines export growth? Three sets of factors: demand, supply and exchange rate. The uncertain state of the world economy means demand is fragile and this is something exogenously given. There is nothing much the Government can do about it. From the perspective of stimulating exports of both goods and services, one would like the exchange rate to depreciate. But capital inflows lead to appreciation. Central bank intervention in foreign exchange markets has costs, quite apart from the fact that one will be accused of currency manipulation. On the supply side, the Government has introduced measures to improve logistics. Exports have also faced issues because some export incentives have been held to be incompatible with the World Trade Organization (WTO) rules. WTO-compatible incentives are now being devised and negotiations are underway for restoring the Generalised System of Preferences benefits.

Higher growth can come from four sources: consumption, investment, government expenditure and net exports. The point of the above is that net exports will continue to be a constraint. Earlier, it used to be said that regardless of the external environment, there was enough endogenous slack in the country to jack up growth to 8-8.5 per cent. There is a slightly sterile debate that goes on about a structural versus cyclical diagnosis. Proponents of the structural view invariably list out reforms in factor markets (land and labour) and privatisation. By privatisation, one is primarily referring to Central public sector enterprises (PSEs), though inefficient state PSEs are no less important. For Central PSEs, privatisation is necessary on efficiency grounds. Plugging the fiscal gap is a secondary consideration. Therefore, the budgetary target for disinvestment (now increased to Rs 1.05 lakh crore for 2019-2020) is somewhat irrelevant. It is important for budget-making and no more. After all, privatisation is a process and cannot be rushed through. For instance, legislative changes may be necessary and one may have to go back to Parliament. Land, the most valuable asset, is, typically, owned by state governments and obtained by Central PSEs on lease, often for a specific purpose. It cannot be sold by the Union Government and has to be returned to states. In terms of beginning the process, the Government has already announced privatisation of Air India, Shipping Corporation, Container Corporation, Teri Hydro Development Corporation and North Eastern Electric Power Corporation.

Land is a state subject, though few people objected when Parliament legislated on a state subject through the 2013 land acquisition Act. Indeed, this legislation has raised land costs and made infrastructure projects difficult. Had states supported the idea, the Act of 2013 would have been amended in 2014. Labour is on the Concurrent List of the Seventh Schedule. Indeed, the present Union Government’s exercise of consolidating labour statutes into four codes doesn’t go far enough, as commentators have pointed out, though fixed-term employment has now become permissible. But the question to ask is this: Why have many of these ‘structural’ reforms been pending since 1991? They haven’t been discovered today. Barring defence and railways, an all-India growth rate of 8 per cent is a function of what happens in state governments. Among major states, why have rates of growth been lower than 7 per cent (as a trend) in Bihar, Jharkhand, Kerala, Rajasthan, Tamil Nadu, Uttar Pradesh, Chhattisgarh, Jammu & Kashmir, Punjab and West Bengal? What does one expect the Union Government to do about these? What does one expect the Union Government to do about judicial intervention (not just courts, but the National Green Tribunal too) or Parliament? Stated differently, there is a political economy reason why structural reforms have been tardy, even though one can continue to harp on them.

In the absence of structural reforms, other than exports, what drove 9 per cent growth rates was primarily the financial sector and this has been subjected to some clean-up. Was the 2016 regulation and formalisation of the real estate market a good thing or should one have let things be? Should one have allowed the hundreds of thousands of shell companies to continue? Should one not have forced errant promoters to exit? Were the Insolvency and Bankruptcy Code and National Company Law Tribunal bad ideas? Some resistance to the Goods and Services Tax is because evasion has been curbed. Indeed, GST should be simpler. There are too many rates: 5 per cent, 12 per cent, 18 per cent and 28 per cent (plus special rates and exempted categories). All products should be part of GST and there should be standardisation. However, if standardisation requires the 28 per cent rate to decline, it also requires the ‘0 per cent’ rate to increase. When computations were done just prior to introducing GST, the average revenue-neutral rate was estimated to be just over 15 per cent (under one set of assumptions). The average GST rate is 11.6 per cent now. In other words, GST has led to a loss in tax revenue. The attractiveness of GST was because of matching of invoices. The present summary form (GSTR-3B) doesn’t allow this and filing of annual returns has also been postponed. Hence, shell companies have been used to evade GST too. We should ask the same rhetorical question: Do we want standardisation, simplification and clean-up? If the answer is in the affirmative, why are there so few takers for the reduced corporate tax rates of 22 per cent (15 per cent)? Is that because one wanted both lower tax rates and exemptions? This continues to be pertinent when we debate reductions in personal income tax rates. That too cannot happen if we want to hang on to exemptions.

There is also the controversial issue of tax terrorism and harassment. Undoubtedly, rent-seeking and harassment occur, especially if unrealistic revenue targets are set. One can clean up processes by reducing human interface, such as through a centralised system for issuing tax notices, cleaning up legacy taxes (such as those on service tax and Central excise), curbing pointless appeals and litigation. However, a moot point still remains. As with the justice system, innocence is not proved prior to a trial. Ex ante, how does one know whether a person is guilty? That’s only determined ex post. In a similar vein, when a case is picked up for scrutiny and investigation, some degree of ‘harassment’ is inevitable. In 2017-2018, how many Indians owned two or more self-occupied houses? I don’t know what your guess will be. But the answer is just 6,537 individuals, of 49.4 million who declared this in their income tax returns. The second house is simply not declared. Should one let this be, or should one investigate? Any investigation will amount to harassment. Should one have allowed the banker-politician-businessman nexus to continue? The unpalatable truth is that much of the financial sector boom was driven by somewhat shady dealings and skeletons continue to tumble out every day—non-banking financial companies (NBFCs) and cooperative banks are examples. No clean-up is costless. It has adverse growth consequences in the short run, until an alternative and more efficient way of doing business emerges and stabilises. One reason for the downturn is precisely this.

No one denies that real interest rates are too high, or that they should decline. But when one speaks of real interest rates, there is a basic interest rate and a risk premium on top of that. When companies complain of high interest rates, they often have in mind the latter. The differential in the spread of risk premiums has increased, perhaps inevitably. This does not contradict the proposition about excessive risk aversion in banks.

As individuals, we wish to pay lower taxes, but desire better physical and social infrastructure from the government. One should remember that with the Finance Commission recommendations, GST compensation to states and committed expenditure (salaries, pensions, interest payment, some Centrally sponsored schemes that have legislative backing), the Union Government’s finances are severely constrained. Nevertheless, to stimulate consumption and investments, one expects lower taxes. In addition, to reverse the downturn, one expects the Government to increase expenditure. Note that the Government already spends a lot (on food security, the Mahatma Gandhi National Rural Employment Guarantee, housing, sanitation, toilets, LPG, electricity, roads, insurance, healthcare, other forms of transport). These improve productivity in the longer term. The fiscal deficit is expressed as a ratio of GDP and there is nothing particularly sacred about the 3 per cent limit. With the denominator lower, if expenditure is not compressed, the fiscal deficit/GDP automatically rises. Therefore, there is deviation from the Fiscal Responsibility and Budget Management Act. However, there are limits to fiscal profligacy. This isn’t only because of credit rating agencies and threat of capital outflow. In the late 1990s, the consensus on fiscal consolidation was achieved with great effort. This was driven by the consideration that costs of fiscal profligacy are borne by future generations.

What is the broad message? (a) There is no gloom and doom in 5 per cent. (b) In 2020-2021, growth will increase to around 6 per cent, but not significantly beyond that. (c) The clean-up will lead to a more efficient and more formal economy, but not overnight. (d) In the 2020-2021 Budget, we will witness the contours of a new pattern of public expenditure.

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