Lessons learnt and unlearnt
The government seems to have been persuaded that fiscal credibility is more important than any other macroeconomic objective, including growth
Both the annual report of the Reserve Bank of India (RBI) and the gross domestic product (GDP) data for the first quarter of 2017-18 came out last week. Regarding the first, media attention was focused on the impact of demonetisation of old notes in circulation. It seems that 99 per cent of the old (demonetised) notes have been deposited in the bank accounts. The balance could well have been accidentally destroyed over the decades they were in circulation in fires/floods etc. Does this imply there was little unaccounted money held in the form of currency notes in the country and that the whole exercise was undertaken on wrong assumptions?
The government has claimed that the number of “suspicious” cash deposit transactions reported by the banking system has gone up by six times to almost 400,000, amounting to ~1.75 lakh crore, and that these are under investigation; that the number of taxpayers has gone up by 25 per cent (but they seem to be small taxpayers); that the benefits of the demonetisation exercise and the goods and services tax (GST) will be seen over the medium and long term. No “big fish” have been caught through demonetisation or the much publicised Panama Papers. (The only major casualty of the latter in the subcontinent was across our western border, where Nawaz Sharif lost his job).
At this point, one cannot but agree with former RBI governor Raghuram Rajan that “the clever find ways around it (demonetisation)” ( Hindustan Times, September 3), and that while “the intent was good, one cannot say that it has been an economic success” ( The Times of India, September 3). One long-term impact of demonetisation, some administrative reforms and GST may well be to give a push to electronic payments and financial technology (“fintech”), in general, a point I will come back to in a later article.
GDP data for the first quarter of fiscal 2017-18 came out soon after the RBI’s annual report was published. The growth rate was a disappointing 5.7 per cent, the lowest in more than three years. The main culprit seems to be the manufacturing sector, with a growth rate of just 1.2 per cent, the lowest in 20 quarters. (The corresponding number for Q1 of fiscal 2016-17 was 10.7 per cent.) Pronab Sen, the former chief statistician, has ascribed the low growth to demonetisation and destocking by businesses. I, for one, am not quite clear about the implications of the latter. For the purpose of getting another perspective on the growth number, I looked up Chapter I, “Assessment and Prospects”, of the annual report; quotes in the following paragraph are taken from this chapter.
It starts by arguing that “the outlook for growth in 2017-18 has brightened, with the likelihood of another favourable monsoon and the implementation of major policy reforms — led by the introduction of the goods and services tax (GST) from July 1, 2017 — that would help to unlock bottlenecks to growth”. Also that “urban consumption too is expected to remain buoyant, following the upward revision in the house rent allowance (HRA) to central government employees as also the likely implementation of the 7th Central Pay Commission (CPC) award at the state level”. But later, it compliments the government for “enhanced fiscal credibility, thereby anchoring inflation expectations in the economy”. Fiscal credibility before whom? The rating companies? Is fiscal stimulus a positive factor for growth or fiscal austerity? On investments in the economy, it is worried that “sluggish growth of industry and fixed capital formation, however, remain areas, which warrant priority in policy attention. The progress in resolving the highly indebted corporates and improving the financial health of public sector banks (PSB) is critical for restarting credit flows to the productive sectors, apart from reviving the investment climate, in general”. Surely the level of non-performing assets suggests less than effective supervision of the banking system? Also, high real interest and exchange rates are unlikely to lead to investments or a flourishing corporate sector. On the latter issue, in his book, Advice and Dissent, former RBI governor Y V Reddy has argued that the central bank needs to avoid “succumbing to the temptations of the appreciation of the rupee”. Are we doing exactly the opposite over much of the last decade?
To come back to the annual report, it argues that “the infrastructure sector is widely perceived to hold the key to revival of growth, top priority was accorded to addressing environmental clearances, land acquisition issues and other structural bottlenecks associated with project implementation”. Will this be enough? There are a large number of infrastructure projects, which, by their very nature, are not suitable for commercial bank financing, but the government seems to have been persuaded that fiscal credibility is more important than any other macroeconomic objective, including growth. Sad!