With the economic crisis deepening, the government will have to hasten reforms
There is now no denying that the second Modi government takes office amid a clear economic slowdown. The first macro data set released under the new Finance Minister, Nirmala Sitharaman’s watch, on Friday, showed an under-performing economy with GDP growth falling to 5.8% in the fourth quarter of 2018-19 and pulling down the overall growth for the fiscal to a five-year low of 6.8%. Growth in gross value added (GVA), which is GDP minus taxes and subsidies, fell to 6.6% in 2018-19, pointing to a serious slowdown. If further confirmation were needed, the growth in core sector output — a set of eight major industrial sectors — fell to 2.6% in April, compared to 4.7% in the same month last year. And finally, unemployment data, controversially suppressed by the Union government so far, showed that joblessness was at a 45- year high of 6.1% in 2017-18. These numbers highlight the challenges ahead for Ms. Sitharaman as she sits down to draft the Budget for 2019-20, to be presented on July 5. The economy is beset by a consumption slowdown as reflected in the falling sales of everything from automobiles to consumer durables, even fast-moving consumer goods. Private investment is not taking off, while government spending, which kept the economy afloat during the last NDA government, was cut back in the last quarter of 2018-19 to meet the fiscal deficit target of 3.4%.
The good news is that inflation is undershooting the target and oil prices are on the retreat again. But the rural economy remains in distress, as seen by the 2.9% growth in agriculture last fiscal; the sector needs a good monsoon this year to bounce back. Overall economic growth in the first quarter of this fiscal is likely to remain subdued, and any improvement is unlikely until the late second quarter or the early third. There are not too many options before the new Finance Minister. In the near term, she has to boost consumption, which means putting more money in the hands of people. That, in turn, means cutting taxes, which is not easy given the commitment to rein in the fiscal deficit. In the medium term, Ms. Sitharaman has to take measures to boost private investment even as she opens up public spending again. These call for major reforms, starting with land acquisition and labour, corporate taxes by reducing exemptions and dropping rates, and nursing banks back to health. On the table will be options such as further recapitalization of the ailing banks, and consolidation. The question, though, is where the money will come from. With tax revenues likely to be subdued owing to the slowdown, the Centre will have to look at alternative sources such as disinvestment. There may be little choice but to go big on privatisation. A rate cut by the Reserve Bank of India, widely expected this week, would certainly help boost sentiment. But it is the Budget that will really set the tone for the economy.
Prime Minister Narendra Modi’s election campaign, staying clear of bread-andbutter issues, successfully swayed voter attention away from economic hardships. Having won a thumping mandate, his government in its second tenure must now devote itself to a wellthought-out strategy for economic reforms.
The bad news
Official estimates released on Friday, the new government’s first day in office, show GDP growth slowed to a five-year low of 6.8% in 2018-19, even as the unemployment rate rose to a 45-year high of 6.1% in 2017-18. Agriculture gross value added (GVA) growth is estimated at negative 0.1% and manufacturing GVA growth at 3.1% in the JanuaryMarch quarter.
The economy is struggling with an investments and a manufacturing slowdown, rural distress, unremunerative farm incomes, stagnating exports, a banking and financial mess and a jobs crisis. Sales figures from fast moving goods makers and continuing production cuts at car manufacturers confirm that consumption spending have slowed. The top economic priority for the new Modi government ought to be credible course correction in its attitude to policy — its formulation, articulation and the setting of goals.
The previous Modi government began well but soon lost direction. The announced plans for what looked like a blueprint for structural reforms — spanning an overhaul of labour and land policies and a much-needed manufacturing push, ‘Make In India’, for absorbing the slack from the farms — had been abandoned by the end of 2015.
The initial energy and enthusiasm gave way to misadventures such as demonetization and the poorly designed rollout of the Goods and Services Tax (GST) regime. Despite repeated reminders to the Prime Minister’s Office from Finance Ministry bureaucrats, the decrepit public banking system and the problems of the financial sector received little policy attention. Even the insolvency and bankruptcy reform, a sound economic reform, that got rolled out rather gradually and tentatively is already in danger of getting diluted.
The cumulative neglect of reforms over the years by Mr. Modi and his predecessors, including Manmohan Singh, has ensured that the economy is falling short of both its growth potential and the people’s aspirations.
That the Constitution was hurriedly amended for rolling out reservations based on economic criteria and that fiscal giveaways for middle class Indians and farmers dominated the Interim Budget presented in February suggest Mr. Modi was not wholly unaware of the magnitude of the challenge on the economic front.
But now, is he listening to sound advice on the solutions needed? The economy’s structural problems cannot be resolved with the sort of political balm Mr. Modi resorted to earlier this year; they demand well-crafted economic remedies.
Public provision of toilets, cooking gas connections and dwellings or Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) wage jobs and income supplement schemes are temporary sources of relief.
They are not an economic growth model or strategies for reducing poverty. They can help the poor survive by providing meagre resources for subsistence. Reducing poverty needs economic growth to generate sustainable livelihoods for the poor.
This cannot be remedied by redistributive taxation policies alone. Deeply entrenched factors hinder the poor’s access to income-enhancing skills, education, health and job opportunities and obstruct the trickle-down of growth to the poor. For instance, the Modi government’s ‘Make In India’ strategy was a step in the right direction, and needs to be revived. Done right, it can absorb the slack from the farms.
Few organized sector jobs get generated in India because industries prefer capital-intensive production despite the economy’s relative abundance of low-wage labour. With many seekers per job opening, labour has low bargaining power relative to employers. If production were less capital-intensive, more organized sector jobs would be created. Plus, labour’s bargaining power would improve.
Successive governments in recent years have only ended up deepening this structural weakness by yielding to the constant clamour by industry lobbies for lower cost of capital. The first Modi government’s record was no different. The economic strategy embedded in ‘Make In India’ got completely side-tracked as its plan for economic revival was reduced to a clamour for fiscal and monetary stimuli.
Mere pursuit of fiscal and monetary policy adjustments is not going to unlock India’s economic growth potential, which is impossible without banking, land and labour reforms that no government so far has been able to deliver.
Will Mr. Modi persist in populism of the past, or take up the backlog of economic reforms pending since the first burst in the 1990s? Will sound economics inform his policies, or will he retain a disdain for economists, preferring instead simplistic, quick but ineffective fixes?
Take small firms. For the role they play in jobs creation, smaller firms ought to be incentivised with easy credit and taxation norms. Instead, the messy GST compliance and refunds framework imposed uneconomic compliance costs on them. These were explained away by the Bharatiya Janata Party’s national executive in September 2018 as ‘creative destruction’, a supposedly necessary culling of informal firms so that the formal economy can thrive. The only way the GST may lead to more formalization of the economy is by putting bigger companies at competitive advantage over smaller ones, a policy outcome that no government should want.
Lastly, no evolution of the policy paradigm will be possible if the crisis of credibility in the collection, estimation and presentation of official statistics is not addressed appropriately. In response to the questions raised over unemployment and GDP statistics, including by wellmeaning and eminent economists and statisticians, the first Modi government did little else than to suppress inconvenient data or allege political motivations. A more mature way of engagement with constructive criticism is called for.
It is common to assess a country’s foreign policy by examining individual bilateral relationships or specific outcomes.
But this risks missing the forest for the trees. While the broad directions of India’s foreign relations — with the neighbourhood, Afghanistan, the U.S., China, Indo-Pacific, Russia, and Europe — have been set over the past several years, the main factors inhibiting India’s performance are ultimately domestic in nature. Three stand out.
The first is trade. It often surprises people that India’s trade-to-GDP ratio is higher than China’s or the U.S.’s. India’s market, and access to it, remains a valuable lever with other countries. But much of India’s commerce involves raw materials and low value-added goods, and is still insufficiently integrated into global supply chains. With global trade stagnant and the World Trade Organization at a standstill, the only way for India to seize a larger share of exports is through well-negotiated preferential trade agreements. India’s past record in this department has been poor, leaving some sectors exposed to dumping and others unnecessarily cloistered. A smarter trade agenda will not only create jobs and drive reforms at home, it could become a potent strategic tool in international affairs.
The second concerns defence. India has the world’s fifth largest defence budget but is also the world’s second largest arms importer. Not only does this compromise national security, it means that India cannot offer an alternative as a defence supplier to countries in its region. Defence indigenisation will require financing for defence capital expenditure; assessments of costs, technology transfer capabilities, and export potential early in the procurement process; and fair competition between the Indian private and public sectors.
The third concerns overseas project implementation. India’s outgoing aid budget has been relatively flat, reflecting a skepticism of grant aid from India’s own experience as a recipient. Instead, it has now started to explore other financing options. Indian overseas credit has increased significantly, with over $24 billion extended primarily to South Asia, Southeast Asia, and Africa. But building on several recent steps will significantly increase the country’s delivery and regional credibility. These include better project planning, more attractive and competitive financing terms, more reliable disbursal of funds, and enhanced coordination and communication with the private sector for implementation.
Many regional policy challenges would be addressed with these three major fixes. None will be easy as they will require tackling vested interests. While the first Modi government made its strategic objectives known and set out a clear direction, key policy interventions in these three areas will now be necessary for India to realise its grander objectives.