A combination of tight monetary policy and slack fiscal policy for the next fiscal is the answer to growth slowdown. (Image: PTI)
Politicians have finally woken up to the growth slowdown. I wrote about these matters in my last column, but revisit the subject as it is now being debated. Yashwant Sinha, as a former finance minister and a senior BJP MP, carries a lot of clout in the BJP and in the country. After three years of unalloyed success (at least in its own eyes and of most other observers), the government is facing some close questioning. The Prime Minister has been made aware that the economy is in a difficult patch. As to Sinha’s criticism, all one can say is that the data show a downward slide, but it is not clear whether this is a trend or due to some special factors. There are two special factors—demonetisation and GST. The former could have affected the GDP growth rate for part of the third quarter of fiscal 2016 and part of the fourth quarter of fiscal 2016. The latter is still in its early implementation stage, but will show its effect in the first two or three quarters of fiscal 2017.
The effects of demonetisation will be no more than a reduction of 0.5% in the GDP growth rate. This is more or less in the data for the last quarter of fiscal 2016, which came a percentage point below the growth rate of the same quarter of a year ago. Add to this some effects in the quarter before then. As these are annualised rates, a one percentage drop indicated a 0.25% reduction in the growth rate. The GST effect is not so much on growth rate as on the estimated revenue collection. It seems the rebate claims are higher than expected. It is a consequence of the complexity of bringing many commodities and services under a single tax. Some highly taxed items are inputs to low-rated outputs and hence the producers earn a rebate. Whatever these effects, the long-run impact of GST on GDP growth will be positive, but it will be partly in lower final prices and partly in higher quantities delivered of goods as well as services.
This somewhat elaborate analysis shows that the dip in growth rates may be due to one-off factors and may not be systemic. The longer-run factor has been the credit famine due to the NPA situation of PSU banks. The government has moved too slowly on this issue. But the consolidation of SBI has been successfully completed. If more such steps simplify the PSU bank structure, credit may flow again. The government should have built a bad bank long ago. Time is short before the next elections and a quick action would pay dividends.
Another reason for the slide in growth rate is international. India had its best growth performance during the first few years of the 21st century because the global economy was booming. India is not as dependent on foreign trade as China is, but it still does benefit from generous capital flows and export demand if the global economy is doing well. During the last three years, the drop in energy prices did benefit India (and the government was right in not passing on the lower prices to car drivers). But these prices have stopped falling. Thus, a part of the growth slowdown is induced by global factors.
As I said in my last column, the deep structural reforms of the land, labour and credit markets will have to be tackled sooner rather than later. But the current critique is about the short run of the next 8-10 quarters. In this respect, the quickest and most effective boost can come only through fiscal or monetary policy. Thus far, the finance minister has been disciplined in terms of reducing the budget deficit. RBI has been hard-nosed about interest rates despite many appeals for rate cuts. Given the fact that the independence of RBI’s monetary policy framework has been only recently established, the government should let RBI do what it wishes. In any case, any flare up in inflation will be very damaging electorally. This leaves fiscal policy as the only available instrument.
The combination of a tight monetary policy and a slack fiscal policy for the next fiscal would be the answer to growth slowdown. It would make sense to boost infrastructure spending to revive growth. Just one example. It is puzzling that train derailments have become regular. The problem is lack of repairs on railway tracks. That is due to shortage of workers who can repair. Would it not be a great idea if Piyush Goyal treated the problem as an emergency one and launched a 12-month blitz to fix all the defects in railway tracks?
He could create thousands of jobs in the process and save lives. One or two more job-creating, infrastructure-spending schemes and the outlook could be rosy again. Getting growth up again is not rocket science.
Author is a prominent economist and Labour peer.
