Putting Economy On Track

As the debate rages on how to return the Indian economy to good health, it is clear that there is very little wiggle room for a government stimulus without breaching the 3.20 per cent fiscal deficit target set by Finance Minister Arun Jaitley for 2017-18. As on August 31, 2017, the fiscal deficit had already consumed 96 per cent of the full year’s target (Rs 5.25 lakh crore out of Rs 5.46 lakh crore).

So if the government wants to pump in more money into the system to boost investment activity, the full year’s fiscal deficit could well hit 3.50 per cent, alarming fiscal purists and foreign rating agencies.

Nonetheless, the government may have few alternatives to kickstart the economy. As economist Ajit Ranade wrote in Mint: “Fiscal consolidation has been one of the prized achievements of the present government. The gains from falling oil prices did not lead to a spendthrift budget. This year the budgeted fiscal deficit of the Central government is 3.20 per cent, which will fall further to 3 per cent in the following year. The 3 per cent fiscal deficit holy grail number has origins in the number agreed by the European Union in the Maastricht treaty. There is no theoretical basis for this. For a country with a young demography like India, the number of unborn taxpayers far outnumbers the currently alive taxpayers. So passing a lighter per-capita tax burden on future unborn generations, through a higher fiscal deficit, is much more feasible for India than Europe. India is a developing country which is bound to have higher debt and deficits.

“India needs to expand fiscal spending in at least three specific sectors: (a) affordable housing, through interest subventions and assistance to states to acquire contiguous land to provide to developers. This can be potentially a big booster; (b) subsidy to employers, by way of full funding of pension funds or part of wage payment of workers and apprentices; and (c) enhanced fiscal support to manufacturing and services export schemes.”

Ranade rightly suggests that the Indian government can expand fiscal spending on schemes in housing, manufacturing and exports. This is critical since the other three engines of the economy are dormant. Private investment has been stalled by cautious bank lending due to persistently high NPAs. Exports remain weak, well below their 2014 peak. The fourth engine, consumption, has been hobbled by the after-effects of demonetisation and teething problems with GST.

Indian GDP over the last six quarters has declined markedly. In the January-March 2016 quarter, GDP growth was 9.2 per cent. In subsequent quarters it fell to 7.9 per cent, 7.5 per cent, 7.0 per cent, 6.1 per cent and 5.7 per cent.

Let’s analyse these figures more closely. In the quarter just before de-monetisation (July-September 2016) GDP growth, while showing a downward trend, was still a robust 7.5 per cent. It is easy to conclude therefore that demonetisation along with GST destocking in June 2017 clobbered growth as both supply and demand fell sharply. The low inflation rate (including briefly negative inflation) points to a deflationary economy which would normally call for a stimulus.

The government still has an opportunity to spur spending if tax revenue in the second half of the year rises steeply on the back of greater GST compliance. Tax receipts are currently up by around 17 per cent over the same period last year. But as GST settles down and compliance increases, the year’s tax revenue target could well be exceeded. Public sector divestment is another arrow in Jaitley’s quiver with several PSU share sales lined up to boost the national exchequer.

Surjit Singh Bhalla, the newly appointed member of the Prime Minister’s Economic Advisory Council, has a contrarian view on sliding GDP growth. He argues that stalled growth may well be temporary due to the structural disruptions caused by demonetisation and GST. His data shows that the income of the poorest of the poor is rising more than twice as fast after demonetisation than before it. Between December 2015 and September 2016, the wages of “ploughmen and carpenters” (whom Bhalla defines as among the lowest paid daily workers) rose by two per cent. However, in the post-demonetisation period, between November 2016 and July 2017, the growth rate in wages of these workers more than doubled to five per cent.

Obviously these constitute a narrow set of parameters which don’t prove conclusively that demonetisation hasn’t hurt daily wage earners across sectors as much as feared. Bhalla’s coup de grace: “Maybe that is why Modi has been winning elections; maybe that is why the growth slowdown (with a little help from the RBI) will soon reverse.”

No two economists though agree on the key question: now what? Clearly some nuanced thinking is required. A fiscal push may be necessary to revive the animal spirits former Prime Minister Manmohan Singh spoke so longingly about. A combination of surpassing both tax revenue and PSU divestment targets could give the Finance Minister elbow room to pump in around Rs 40,000 crore into the economy without seriously breaching the 3.20 per cent fiscal deficit target. (Remember, every 0.1 per cent increase in the fiscal deficit represents around Rs 18,000 crore.)

The other three engines of growth must simultaneously fire. Overall investment has dipped to around 28 per cent of GDP. The savings ratio has fallen to 30 per cent of GDP. Both were about a third higher in 2013-14. Till corporates begin investing and consumers start saving, GDP growth will remain subdued.

The Finance Minister must meanwhile keep his promise to cut the corporation tax rate to 30 per cent and remove exemptions to improve compliance in a post-GST environment. To boost consumer spending, Jaitley must rationalise direct tax rates. Far too much time and resources are spent by the income-tax department on chasing low-value taxpayers. As GST, which covers large and small businesses, has shown, 95 per cent of tax revenue comes from five per cent of taxpayers, an admission Jaitley himself made publicly on September 28. It is a sobering statistic. India’s economic policymakers are missing the wood for the trees.