Ja­hangir Aziz

In­dia will have to re­cast poli­cies and re­forms, look more in­ward and less out­ward as gen­er­at­ing more do­mes­tic de­mand will be key to fu­ture growth

India Today - - INSIDE - Ja­hangir Aziz is Chief Emerg­ing Mar­kets Econ­o­mist, J.P. Mor­gan

THE DOM­I­NANT NAR­RA­TIVE ABOUT IN­DIA’S cur­rent eco­nomic slow­down can be sum­marised in two words: bad tim­ing! Just when the global econ­omy en­tered its strong­est cycli­cal lift since 2010, In­dia was be­set by the un­for­tu­nate but un­in­tended con­se­quences of a se­ries of pol­icy de­ci­sions— de­mon­eti­sa­tion, teething prob­lems of the Goods and Ser­vices Tax, and the re­struc­tur­ing of bad debt in banks—that have tem­po­rar­ily dis­rupted do­mes­tic sup­ply chains. Once th­ese fade, the global tide will lift In­dia to higher growth. Mean­while, re­forms should con­tinue fo­cus­ing on eas­ing the cost of do­ing busi­ness, while mon­e­tary and fis­cal poli­cies should pro­vide short-term re­lief to ease the bur­den of ad­just­ment. Thus the call for cut­ting the pol­icy in­ter­est rate, a weaker cur­rency and tol­er­at­ing a higher fis­cal deficit for this year and next. Given the lan­guish­ing pri­vate in­vest­ment, the fis­cal ex­pan­sion should tar­get higher in­fra­struc­ture spend­ing and sub­si­dies for low- and mid­dle-in­come hous­ing, but with elec­tions around the cor­ner, some sup­port could be set aside for farm­ers too.

Prima fa­cie, the logic ap­pears im­pec­ca­ble, ex­cept that it has lit­tle to do with re­al­ity. Let’s start with global growth. Since the sec­ond half of 2016, the global econ­omy has wit­nessed a mas­sive syn­chro­nised cycli­cal lift: de­vel­oped economies have fired on all cylin­ders, i.e., both con­sump­tion and in­vest­ment, while emerg­ing mar­kets have re­cov­ered smartly. 2018 prom­ises to be even bet­ter. Both the Euro area and the US should grow much faster than trend, while emerg­ing mar­kets con­tinue to re­cover apace de­spite a pol­icy-in­duced slow­down in China. Im­por­tantly, even with labour mar­kets tight­en­ing and com­mod­ity prices re­cov­er­ing, in­fla­tion­ary pres­sures re­main mild. Thus, cen­tral banks in de­vel­oped economies will con­tinue to tighten mon­e­tary pol­icy at a mea­sured pace keep­ing fi­nan­cial con­di­tions be­nign.

How­ever, un­der­ly­ing this cycli­cal bounce is a global econ­omy mired in struc­tural malaise. Mea­sured pro­duc­tiv­ity al­most ev­ery­where has de­clined since the fi­nan­cial cri­sis in the ab­sence of any mean­ing­ful sup­ply-side re­form any­where. Even the much-touted tax re­form in the US will likely only boost neart­erm de­mand with­out in­creas­ing medi­umterm sup­ply. With ca­pac­ity in­creas­ingly strained af­ter eight years of ex­pan­sion, and

pro­duc­tiv­ity flagging, even­tu­ally wages will rise, push­ing up in­fla­tion and forc­ing cen­tral banks to tighten more ag­gres­sively. Al­ter­na­tively, growth will need to slow suf­fi­ciently to take off the pres­sure on wages and in­fla­tion. In ei­ther case, this goldilocks world of high growth and low in­fla­tion is un­likely to last for long.

Be­yond the de­vel­oped economies, the only other source of ma­te­rial global de­mand comes from China. At the re­cently con­cluded 19th Congress, the rul­ing Com­mu­nist Party for­mally ac­knowl­edged that China was no longer a low-in­come econ­omy chal­lenged by the need to gen­er­ate mil­lions of jobs, but a ris­ing mid­dle-in­come coun­try as­pir­ing for a bet­ter qual­ity of life. Back in 1981, Deng Xiaop­ing iden­ti­fied in­creas­ing growth to re­place class strug­gle as the prin­ci­pal ob­jec­tive of the Party. For the next three decades, of­fi­cials at the pro­vin­cial and lower lev­els of govern­ment fo­cused solely on achiev­ing high growth by any means nec­es­sary, even if it meant cir­cum­vent­ing ef­forts by the cen­tral govern­ment to cool the econ­omy and con­tain grow­ing vul­ner­a­bil­i­ties. If the pre­vi­ous three decades are any guide, this align­ment of ob­jec­tives be­tween the state and the Party could have just as dra­matic an im­pact with of­fi­cials at all lev­els work­ing to re­bal­ance the econ­omy. This most likely will slow growth in China in the com­ing years.

Turn­ing to the In­dia-spe­cific fac­tors, much has been blamed on the ad­verse im­pact of de­mon­eti­sa­tion, GST and bad debt as the cul­prits be­hind the growth slow­down. While it is un­de­ni­able that th­ese were dis­rup­tive, per­haps even more than ap­pre­ci­ated to­day, it is hard to pin the en­tire blame on them. The rea­son is ob­vi­ous: In­dia’s growth has been slid­ing since the sec­ond quar­ter of 2016, six months be­fore de­mon­eti­sa­tion and a year be­fore the in­tro­duc­tion of GST. While the bad debt prob­lem hit head­lines in 2016, over-lever­age had al­ready be­gun to tighten bank lend­ing since 2014.

So what caused the de­cline in growth since 2016? It was the re­ver­sal of what drove growth up in 2014-15, namely oil prices. Global oil prices af­ter peak­ing in the sec­ond half of 2013 fell nearly 70 per cent over 2014-15 to bot­tom out in the first quar­ter of 2016. This out­sized de­cline was a mas­sive pos­i­tive shock to In­dia that is es­ti­mated to ac­count for al­most the en­tire growth pick up over 2014-15. Since early 2016, oil prices have nearly dou­bled, im­part­ing a large neg­a­tive shock that has driven down growth since then. The de­mon­eti­sa­tion, the GST and the bad debt just made a bad sit­u­a­tion worse; they did not cause it. Un­der­stand­ably, many will ar­gue that this nar­ra­tive un­der­plays the im­por­tance of the tec­tonic shift in pol­i­tics dur­ing this pe­riod and the at­ten­dant changes in pub­lic sen­ti­ment and govern­ment de­ci­sion-mak­ing. I am not. I am just stat­ing that

fac­tu­ally global oil prices played a much big­ger role in quan­ti­ta­tively ex­plain­ing In­dia’s growth dy­nam­ics since 2014 than any of th­ese other fac­tors.

To know where we might be headed in 2018 and be­yond, we need to bet­ter un­der­stand how we got here first. Once we re­ject ad hoc and co­in­ci­den­tal ex­pla­na­tions, we wade into a world of in­el­e­gant and com­plex answers that of­ten re­quire dis­card­ing long-held mis­con­cep­tions. I am go­ing to be­gin with one such mis­con­cep­tion. In­dia is, and has been, for a long time far more open to the global econ­omy than be­lieved. There is vir­tual con­sen­sus among an­a­lysts and pol­i­cy­mak­ers that the dra­matic rise in in­vest­ment drove much of In­dia’s vaunted 9 per cent growth over 2003-08. The lib­er­al­i­sa­tion of 1991-92 cou­pled with the cor­po­rate re­struc­tur­ing in the late 1990s spurred cor­po­rate in­vest­ment to rise from 5-6 per cent of GDP in the early 2000s to 17 per cent of GDP by 2008. But it takes two to tango. The in­crease in in­vest­ment also pro­duced a lot of things that some­one had to con­sume. De­spite the ex­plo­sion of shop­ping malls in ev­ery nook and cor­ner, it wasn’t do­mes­tic con­sump­tion that ab­sorbed the rise in pro­duc­tion as is widely be­lieved. It was ex­ports. It grew at an as­ton­ish­ing pace of nearly 18 per cent per year. Pri­vate con­sump­tion, on the other hand, grew at 7.5 per cent, even less than the growth rate of the econ­omy such that its share in GDP fell from 62 per cent to 57 per cent. To put this in per­spec­tive, even af­ter de­clin­ing over the past few years, ex­port’s share in GDP in In­dia at 20 per cent is the same as in In­done­sia and twice that in Brazil.

The sub­se­quent de­cline in in­vest­ment, from its peak of 37 per cent of GDP in 2012 to below 30 per cent of GDP at present, is also widely ac­cepted as the key rea­son be­hind the slow­down trend in growth. But cor­po­rate in­vest­ment had plunged way back in 2009, flatlin­ing at around 12 per cent of GDP since then. Mean­while, pri­vate hous­ing and SME in­vest­ment have fallen from 15 per cent of GDP to around 10 per cent in the past five years.

Th­ese have cru­cial im­pli­ca­tions for In­dia’s medi­umterm growth. In­dia’s 9 per cent growth over 2003-08 was on the back of ex­ports surg­ing at 18 per cent per year. In the past five years, ex­ports grew at just 3 per cent an­nu­ally. Even if ex­ports were to grow at dou­ble the pace in the com­ing years, it is hard to see over­all growth ex­ceed­ing 7 per cent. Pri­vate in­vest­ment in In­dia has wal­lowed not be­cause fund­ing costs are too high or banks are ham­strung with bad loans or the ex­change rate is too ap­pre­ci­ated as is gen­er­ally be­moaned to­day. It is be­cause there isn’t suf­fi­cient de­mand to jus­tify large in­vest­ments. In other words, with global growth likely to slump back to medi­ocrity, 7 per cent will be the new 9 per cent un­less we find off­set­ting do­mes­tic driv­ers to in­duce cor­po­rates to raise in­vest­ment.

This is eas­ier said than done as it re­quires re­think­ing a frame­work that has been the ba­sis of poli­cies and re­forms since In­dia’s in­de­pen­dence. As long as one cares to re­mem­ber, In­dia has been a sup­ply-con­strained econ­omy with a struc­turally high in­fla­tion and a nag­ging cur­rent ac­count deficit. Poli­cies and re­forms, al­most ex­clu­sively, have been geared to ease sup­ply con­straints across the econ­omy: from in­fra­struc­ture spend­ing to re­cap­i­tal­is­ing banks and, most egre­giously, forc­ing house­holds to keep in­creas­ing sav­ings (for re­tire­ment in­come, chil­dren’s ed­u­ca­tion, health­care, and hous­ing) through a web of fi­nan­cial re­pres­sion, reg­u­la­tory distortion­s and pub­lic spend­ing choices.

To be fair, this sin­gle­mind­ed­ness was the right ap­proach as long as there was suf­fi­cient for­eign de­mand to ab­sorb the goods and ser­vices pro­duced by the coun­try. Not any longer. The hard bit is to ques­tion and re­jig a 70-year-old frame­work and then to build con­sen­sus across cen­tral, state and lo­cal gov­ern­ments for the need to change. Re­cast­ing poli­cies and re­forms is less ar­du­ous and it starts with re­design­ing In­dia’s in­fra­struc­ture to look more in­ward and less out­ward, in­creas­ing pub­lic pro­vi­sion­ing of health­care and ed­u­ca­tion, re­form­ing in­sur­ance reg­u­la­tions to re­duce forced sav­ings for old-age care, and elim­i­nat­ing fi­nan­cial re­pres­sion to raise re­turns on re­tire­ment sav­ings.

While no coun­try with $1,800 per capita in­come has man­aged to sus­tain high growth with­out re­ly­ing on ex­ports, it is also un­likely that global trade will re­turn to any­where close to its pre-cri­sis growth rate. Thus, the pru­dent choice would be to shift the bal­ance of poli­cies to­wards gen­er­at­ing more do­mes­tic de­mand. Will this hap­pen? One hopes so. Be­cause 7 per cent growth may not be good enough: grow­ing at this pace for the next 25 years will raise In­dia’s per capita in­come to just about 15 per cent that of de­vel­oped coun­tries and half that of its Asian peers.

TO SUS­TAIN HIGH GROWTH WITH­OUT RE­LY­ING ON

EX­PORTS IS THE CHAL­LENGE; GLOBAL TRADE IS UN­LIKELY TO RE­TURN TO PRE-CRI­SIS GROWTH LEV­ELS

Illustrati­on by TANMOY CHAKRABORT­Y

By JA­HANGIR AZIZ

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