Three areas budget must focus on to revive economic growth

While govt consumption has grown at a faster rate than last year, private consumption and investment growth is slower

The forthcoming Budget will be presented at a time when India’s economic growth is expected to be 5%, the lowest since 2008-09. The situation is even worse if one looks at nominal growth, which is GDP growth without accounting for inflation. Nominal GDP growth in 2019-20 is expected to be 7.5%, the lowest since 1975-76. Given this context, reviving growth has to be the most important priority for the budget. Whether or not the budget can deliver on this will depend on how it acknowledges and addresses three key factors.

Slowdown is widespread across sectors: The current slowdown in the Indian economy is spread across sectors. All three key sectors, agriculture, industry and services are expected to grow at a slower pace in 2019-20 than 2018-19.

To be sure, the mining subsector within industry and public administration, defence and other services within services have grown at a faster rate than last year.

From the expenditure side, it is only government consumption which has grown at a faster rate than last year, while private consumption and investment growth has slowed down.

This also means that lack of private demand is the biggest reason for the slowdown (more on this later).

This has two important implications for the budget. First, the government cannot focus on just one particular sector to revive economic activity. Second, any aggressive reduction in government spending to keep the fiscal deficit in check, could end up squeezing GDP growth even further, as it will entail a reduction in the government component of GDP. (See Chart 1)

Reviving economic sentiment is the biggest challenge: Arresting the current growth slowdown is not just about boosting purchasing power and hence aggregate demand.

Even if the government decides to give a spending driven stimulus to the economy, it will take time to achieve its objective. The Indian economy has been showing some green shoots since the last quarter. Growth in factory output as measured by the Index of Industrial Production (IIP) turned positive in November after contracting for three consecutive months. Purchasing Managers’ Indices (PMI) for both manufacturing and services have been growing since October 2019. However, the sharp spike in food inflation might have put a further squeeze on non-food spending.

The Reserve Bank of India’s Consumer Confidence Survey for November 2019 (the latest available figures) also shows a continuing drop in consumer sentiment. This is in keeping with the ongoing deceleration in non-food credit until November 2019, the latest available figure. A deceleration in credit growth suggests that both enterprises and consumers might be postponing their investment/consumption decisions.

It is these consumers and producers who will be expecting a boost to economic sentiment in the budget. (See Chart 2)

Factoring in the importance of the informal economy: Formalisation of the economy, even by coercion, has been a defining feature of this government’s economic policies. Demonetisation and the Goods and Services Tax (GST) were the most important policy instruments to achieve this goal. The underlying wisdom behind such policies was that formalisaton would widen the tax net and boost revenue collections, allowing the government to spend more on economic growth and welfare.

However, the experience so far suggests that this has not happened. Instead, the economy seems to have taken a hit and the actual growth rate (7.5%) has fallen significantly short of projected nominal growth rate (12%) in the budget.

The mid-year steps taken to revive the economy have mostly focused on providing relief to the formal sector. The biggest example of this is a reduction in corporate tax rates in September 2019. This move, according to government estimates will lead to a revenue loss of ~1.45 lakh crore. This is more than the entire amount allocated for PM-KISAN (~75,000 crore) and MGNREGS (~60,000 crore) in the current fiscal year. Schemes such as the PM-KISAN and MGNREGS amount to a direct enhancement in the purchasing power of millions across the country, and any significant boost in such payments would have given a direct boost to mass demand.

Among the most telling proof of a squeeze on the informal sector under the current government is the tepid growth in rural wages.

According to the Consumer Price Index for Agricultural Labourers, real rural wages have been contracting continuously from March 2019 to October 2019, the latest period for which data is available.

Unless this metric sees a sustained improvement, a revival in mass demand will continue to elude the Indian economy. (See Chart 3)

EVEN IF THE GOVT

DECIDES TO GIVE A SPENDING DRIVEN STIMULUS TO THE ECONOMY, IT WILL TAKE TIME TO ACHIEVE ITS OBJECTIVE