State of the economy: An alternate view and the course ahead
The current slowdown in the economy can be revived only if demand starts picking up.
The NDA government earned a decisive mandate in the 2014 general elections on account of its promises of development, higher growth and structural reforms with the eventual target of creating jobs. While the first half of the BJP-led NDA government’s term has witnessed high growth (with India even being termed the fastest growing large economy in the world), the deceleration of the GDP to 5.7% during the first quarter of the current fiscal, and the projections of diminished growth for the rest of the year have led to a sudden weakening of sentiment of the hitherto gung-ho foreign investors. The government has suddenly come under attack from several corners and comparisons are being drawn with the economic performance during the UPA years. The criticism being levied is based on the difference in the top line GDP figures, while completely ignoring the circumstances and the means adopted by either regime to attain those growth rates. The growth rate during 10 years of UPA years averaged at 7.7% per annum. While this may prima facie appear to be an impressive feat, what is often ignored is the fact that there is a direct linkage (as established by statistical analysis published by Morgan Stanley) between India’s growth rate over any five-year period since 1980 and that of the other emerging economies. Since 1980, the Indian economy has been growing at an approximate positive delta of 200 basis points over the average growth rate for other emerging markets (on account of a lower per capita base income), and the period between 2004-2014 was no exception. Clearly, the high rate of growth achieved during the UPA years was on the back of a tide of high rate of global growth. If we factor in the high rates of inflation during the UPA rule, the economic development achieved appears to be even more modest. Further, the dominant factor for the high rates of growth achieved (8.5% in 2009-10 and 8.9% in 2010-11) post 2008, when the world was still grappling with the global meltdown, was the artificial demand created due to a fiscal stimulus in excess of INR 3.20 lakh crore by way of increase in planned expenditure and additional liquidity infused through reduction in rates of indirect taxes and lowering of key rates by RBI. The stimulus package announced by the UPA government post the global meltdown was acknowledged publicly as a key reason for UPA’s loss in 2014 by none other than P. Chidambaram, as it led to inflation in excess of 14%. The growth rates in the remaining years of the UPA term nosedived, while the inflation rate and current account deficit continued to be stubbornly high. Several corruption scandals broke out along with attempts at retrospective taxation, which dampened the confidence of domestic and foreign investors alike. Looking back, there was no ray of hope for the Indian economy at the time Prime Minister Narendra Modi assumed office in May 2014. The average growth rate for the Indian economy during the first three years of the Modi government has been 7% (against the emerging market average of 4%). The government managed this against extreme odds. During 2014-15, the global economy was still recovering from the financial crisis of 2008 and was being propelled by only one engine— the United States—with the Chinese economy growing at its lowest, after averaging 10% per annum in the prior decade. Further, 2014-16 were also marked by economic and political uncertainties in Europe (high rates of unemployment, threat of Greek sovereign default, political referendums etc.). At home, the situation was no better, with a literal credit freeze by public sector banks to private businesses on account of NPAs accumulated during the UPA years, slowdown in exports due to a weak global economy, and a bureaucracy that was hesitant to take any decisions fearing the office of the Controller and Auditor General of India, and the Central Bureau of Investigation. With little support coming in from the private sector, it was left to the public sector to prop up the economy. The government was left with a double-edged sword, as any significant increase in public spending would have fuelled inflation and derailed the course of fiscal discipline that it had committed itself to. Further, the estimated Rs 70,000 crore set aside for implementation of the 7th Pay Commission in the Budget of 2016-2017 did not leave the government with much headroom for fresh capital expenditure. And yet, the Modi government, through systematic and persistent efforts and reforms managed to achieve higher growth than the last two years during the UPA rule.
The government accorded top priority to foreign direct investment, with the Prime Minister meeting industry leaders in host countries and personally urging them to invest in India. As a result, in 2015, India became the top destination for foreign direct investment. In parallel, to boost the confidence of domestic industry, the government started to focus on ease of doing business and solving the NPA issue (in excess of INR 700,000 crore), starting with the enactment of the bankruptcy law. On the demand side, the government has kept inflation under check, left more money in the pocket of small taxpayers and committed to double farmers’ income in the next five years, apart from ensuring low rate of retail inflation and a strong rupee.
The government has also been focusing on carrying out structural reforms, something which had been lacking during the UPA rule. With the objective of digitisation and elimination of unaccounted cash, the government carried out demonetisation late last year. In addition, GST was introduced to curb tax evasion and raise more taxes to be used for public welfare schemes such as subsidised housing. However, since these reforms are structural in nature, they have caused some disruption in the economy, which has led to a decline in domestic growth and a resulting decline in the GDP figures for the first quarter of the current financial year. The current slowdown in the economy has been on account of slowdown in domestic demand and revival of the economy is only possible if demand starts picking up. This would require a combination of both short term and long terms measures, leveraging of structural reforms already carried out as well as avoid mistakes that can destabilise the economy. * FISCAL STIMULUS: In the absence of investment from the private sector, governments typically consider increasing capital expenditure, as this acts as a trigger for private investment. According to a paper published by Sukanya Bose and N. R. Bhanumurthy (Consultant and Professor, respectively, at the National Institute of Public Finance and Policy), for every crore of capital expenditure done by the government, there is a multiplier effect of 2.45 in the subsequent 12-month period. Assuming, that the government introduces a stimulus of INR 40,000 crore as additional capital expenditure in the coming months, it could result in an increase in GDP of about INR 100,000 crore, which will amount to an incremental 0.5% growth in GDP. However, there may be very few projects that the government may be able to identify, which can be completed in the next six-eight months to start yielding multiplier returns before the next general elections. Hence, increased capital expenditure allocation at this point may yield sub-optimal economic results. Any other stimulus in the form of increase in subsidies will fuel inflation and will not be sustainable in the long term. * ABOLISHING PERSONAL INCOME TAX: Abolishing personal income tax will result in increased savings across the tax base, which can be used to start the next investment cycle. In addition, the increase in demand will help create jobs, a parameter on which the Modi government has not fared too well. The revenue forgone from personal income tax will be in the range of INR 250,000 crore, which can easily be recovered by way of increased indirect tax collection if the state governments are able to plug a gap on electricity theft in India, which is estimated at over INR 1 lakh crore per annum. Assuming that only 50% of the electricity being currently stolen is used for commercial purposes and that electricity amounts to 5% of the sale price (net of tax), the estimated worth of goods evading GST could be to the tune of INR 20 lakh crore and current revenue evasion (at dominant rate of 18% GST) would itself come to INR 3.6 lakh crore, of which the Centre could earn about INR 1.8 lakh crore. This amount will alone cover about 70% of the revenue foregone and the government could raise the balance from increase in corporate earnings. * AMNESTY SCHEME FOR DECLARATION OF GOLD AND BENAMI PROPERTY: The gold bonds introduced with the objective of channelising over 25,000 tonnes of estimated gold holdings into financial instruments have not been met with much enthusiasm by individuals. This may largely be on account of the fact that majority of the gold purchased in India is through unaccounted income. At current price levels, the estimated value of gold holdings of Indians could be in excess of $700 billion. The government should introduce a one-time amnesty scheme to allow individuals to declare their gold holding upon a onetime payment of 10% tax on the value of the gold declared, post which more people are likely to participate in the purchase of gold bonds offered by the government. A similar approach could also be adopted for benami properties. The government could also offer individuals, in lieu of a one-time tax, low yield fixed term infrastructure bonds. * DOWNSIZING OF GOV- ERNMENT MACHINERY: The 7th Pay Commission has impacted government expenditure by nearly INR 1.5 lakh crore and counting. Unfortunately, bulk of government expenditure is in servicing salaries and pensions, leaving little for productive expenditure. Health and education sectors are screaming for funds. However much private sector may invest in social sectors, the programme of health and education for all has to be government funded. As per estimates, the travel allowance/dearness allowance expenditure of the Central and State Governments is more than some of the social sector schemes. Though considerable progress is being made to hive off non-performing assets of the government, yet the perks government officers have squeezed out are a constant drain on valuable resources. * REMOVAL OF SUBSIDIES AND PSU CULTURE: The subsidy burden built up over 70+ years is hard to dismantle at one go. Though economically and socially backward persons require government support, yet the leakages in the system have resulted in siphoning off the funds meant for the poor and the needy. The end of subsidies and schemes like MNREGA can be offset by Universal Basic Income. The Jan Dhan Yojana has already laid the platform for its implementation. * IRRIGATION AND MULTIPURPOSE PROJECTS: Even though agriculture contributes to only about 20% of the GDP, it employs nearly 70% of the Indian workforce. Each year, the breast beating of poor monsoon starts. The rain spread across India during monsoon season is uneven, and each year certain areas receive excess and other areas remain deficient. The only way is to store water. Water harvesting, while recharging ground water, cannot be a substitute for large dams. Unfortunately, misplaced activism has starved India of the most important resource. Recently, the dedication of the Sardar Sarovar project, the fact that it was conceived in 1951, bemused many. The bemusement turns into incredulity with the fact that the last multipurpose project was the Tehri dam project sanctioned in 1973 and completed in 2006. The lack of hydropower means shortage of peaking power. The installed hydropower capacity as a percentage of total installed capacity is currently languishing at only 20%, compared to an ideal rate of 40%. Most western countries exploited their hydro potential before venturing into alternate resources. The multipurpose projects, coupled with the interlinking of rivers, are the only way to satiate the burgeoning demand for water for irrigation and drinking. * EMPLOYMENT GENERATION: The rampant change in technology and advent of artificial intelligence will make most manufacturing jobs redundant at a time when the government is banking on “Make in India” to create employment opportunities for the nearly 17 million Indians that join the workforce each year. In a country, where over 70% of the qualified engineers are considered unemployable by the industry, this could pose a huge socio-economic challenge. It will be vital for the government to focus on skill development and work closely with the industry to understand the skill requirement for the future. An education system which promotes independent thinking, questioning status quo and innovation, will be key. * UNIVERSAL HOUSING: The government has recently set a target for universal housing by 2022 as part of which government will bear some of the interest cost. While no one can argue with the social benefits of this scheme, we must all remember that it was the housing bubble that led to the recession of 2008. The conditions under which US policymakers had pushed for housing—low rate of job creation and stagnant income levels—prevail in India today and if under political pressure, PSU banks end up offering housing loans to sub-prime lenders, it could potentially create another, and perhaps much bigger, NPA mess than the one that banks are currently dealing with. The answer to avoiding this mess perhaps lies in tying up the affordable housing schemes with the Universal Basic Income. Akhil Arora has completed Master of Laws from University of Chicago Law School and was a recipient of the Russell Baker Scholarship Fund