What should be done to revive economic growth?

That the Indian economy is caught in a slowdown is beyond doubt. GDP growth rate has declined for four consecutive quarters. Between March 2018 and March 2019, it has come down by 2.3 percentage points. Given the downward revision in projected growth rates by most institutions including the Reserve Bank of India (RBI), any immediate revival is unlikely.

What can boost growth in the Indian economy today?

The answer to this requires a clear understanding of two basic questions. Is the current slowdown structural or cyclical in nature? And, what exactly has led to it?

The structural versus cyclical distinction is extremely important because this has a direct bearing on the choice of policies to boost economic activity. If the slowdown is only cyclical, then there is no need for a long-term plan to boost growth. Short-term measures are what should be looked at. However, if there’s a structural element to the slowdown, then this means that some of the key ingredients that contributed to growth are not available any more (or are no longer helping the cause of growth). This means economic policy has to be re-strategised to find new potential drivers of growth. It is entirely likely that the slowdown in economic activity is a result of a mix of structural and cyclical factors. This will then require both short-term and long-term measures to promote growth.

The most common argument put forth by people who believe the slowdown is cyclical is the following. The Indian economy suffered two big back-to-back shocks before the Narendra Modi government took over in 2014. The first was the global financial crisis of 2008, which adversely affected export demand. Then came “policy paralysis” during the second United Progressive Alliance (UPA) government, which led to several big-ticket projects being stalled. This was followed by a complete aversion to decision-making in the government. These two developments played havoc with credit cycle as borrowers were unable to pay the huge loans they took in anticipation of the boom continuing, and banks were saddled with huge Non Performing Assets (NPAs). This led to the “twin-balance sheet” problem in the economy with banks being short of funds to lend, and entrepreneurs not having the appetite to invest more given the already pending loans on their books. The government claims that the twin-balance sheet crisis is on its way to being resolved, with recapitalisation provisions for government-run banks and the Insolvency and Bankruptcy Code (IBC) to deal with NPAs. This is expected to take care of the current slowdown in demand. Prime Minister Narendra Modi hinted at this in his interview to The Economic Times on August 12. “We are facing some headwinds on this [demand]. One of the major reasons for domestic demand being curtailed is the credit constraints. So, it is a vicious cycle, which is at its last stage,” Modi said.

A look at investment data from the Centre for Monitoring Indian Economy (CMIE) suggests a bleaker picture. New investment announcements, an indicator of intent rather than actual investments, have been falling continuously since 2014. That even investment announcements are not picking up at a time when the government thinks the twin balance sheet crisis is in its last leg, suggests that entrepreneurs are not optimistic about future economic activity. This is also seen from the fact that the value of dropped investment projects has been increasing in the recent period. This means that entrepreneurs are not confident about implementing their existing plans, which makes it extremely unlikely that new investment plans will be made. The value of investment projects completed has been nearly stagnant in this period. The short point is that entrepreneurs do not see the current slowdown as merely cyclical.

If the slowdown is indeed structural, what are its elements? The first is the negative shock to exports. Exports as a percentage of GDP rose constantly in India until the global financial crisis hit in 2008. There was a brief recovery after the crisis, but since then there has been a sharp fall in share of exports in India’s total GDP. After having reached a peak of 17% in 2013-14, exports accounted for just 12.1% of India’s GDP in 2018-19. Deepening trade wars and the current slowdown in the global economy does not bode well for future export growth. This means that an important driver of past growth has been weakened significantly. Exports are only one side of the story in foreign trade’s impact on GDP growth. A country can also add to its GDP by reducing imports. So, reducing imports can have the same impact on domestic economic activity as increasing exports. India can do little to reduce imports such as petroleum. However, even non-oil trade balance has been worsening for India. Non-petroleum imports were less than or equal to non-petroleum exports until 2000, but the dynamic has changed since. By 2010, imports were 1.3 times exports.

Although there have been fluctuations after that period, the number continues to remain the same. Reducing the non-petroleum trade deficit can give a big boost to the domestic economy. This is not going to happen on its own. The government should ideally identify sectors where it wants to reduce imports and then provide attractive incentives to both foreign and domestic entrepreneurs who are willing to invest in these sectors within a reasonable but short window. This should ideally be the beginning of the making of a long-term trade and industrial policy for India. Much of the focus of the Modi government has been on non-targeted investor-friendly measures such as boosting India’s rankings in Ease of Doing Business indicator rankings. It is time to supplement these policies with aggressive import substitution. There is some merit in even adopting an aggressive stance on this front at the moment, as the current chaos in the international trading order can help India negotiate some roadblocks which would not have been easy earlier.

Such targets will provide tailwinds to economic growth only in the medium- to long-term. What about the short-term challenge to revive growth? We have argued in these pages that a push for formalisation, leading to a squeeze on unaccounted incomes, and worsening of terms of trade against agriculture are two major reasons for the weakening of aggregate demand in the Indian economy. This slowdown in demand has affected earnings in even the formal sector of the economy. What can be done to boost demand?

The first prerequisite for a revival is a boost in spending, especially on consumer durables such as automobiles. The government is one of the biggest employers in the Indian economy. A significant proportion of government jobs are permanent in nature, so the workers are assured of future income flow. Any policy which incentivises government employees to advance their spending decisions can give a big boost to current levels of demand. An interest rate waiver on loans from sources such as Employees Provident Fund Organisation (EPFO), which is workers’ own money, or a tax rebate on big-ticket spending for the current fiscal year are examples of such a policy.

EPFO alone has a corpus of Rs 11.5 lakh crore. The central government is expected to spend around Rs 4 lakh crore in salaries and pensions this fiscal year. In 2017-18 (latest available data), the combined spending by states on wages and salaries was Rs 3.2 lakh crore. These numbers suggests that government employees advancing their consumption decisions can give a big boost to economic activity. Some of these incentives could also work for the private sector. Even if the government loses some amount in direct taxes, its indirect tax receipts are bound to increase.

Another sector where there is a scope for boosting consumption is agriculture. This government takes a lot of credit for maintaining a low inflation environment.

Low food prices have played a big role in controlling inflation. This has led to a squeeze on farmers’ incomes. If food prices continue to be depressed for a long time, rural demand will be difficult to revive. There is one way in which the government can use low food prices to actually boost demand in the economy. Majority of Indians spend a significant part of their incomes on food. Despite this, India continues to have a low nutrition society with nutrient intakes being far less than not just developed country levels, but also countries such as China.

A widening of the current food security programme in India, which moves beyond cereals and focuses on sectors such as horticulture and dairy – both of which are in a big crisis – can give a boost to demand for these food items. Such polices need not take the traditional procurement route used by the Food Corporation of India.

The concept of farmers’ markets, like in the US, is useful in this context. The US food security programme entitles beneficiaries to spend cash transfers to buy from markets where only farmers are allowed to sell. Promoting such a model will also shift some of the profits in the food economy currently going to corporate players towards farmers. Such a policy will not be in conflict with World Trade Organisation requirements as well. It could be rolled out on a pilot basis and then expanded gradually. Spending money this way is probably better than giving Rs 6,000 per year to all farmers, which is too insignificant a sum to make tangible difference.

The measures discussed here will not lead to a big fiscal shock immediately. They also have the advantage of having a more definitive impact on economic activity unlike rate cuts, which can also have a negative impact. For example, a pensioner who is living on interest earnings from fixed deposits would actually face a squeeze on incomes each time the interest rate is cut.

A good starting point to address the slowdown would be an admission that India faces a demand-side problem in the economy, which needs to be addressed both on a long-term and short-term basis.

First Published: Aug 18, 2019 08:37 IST