How B R Shenoy Would Have Tackled The Economic Slowdown

The slowdown in the Indian economy is characterised by lack of consumer demand, stagnant private sector capital generation and a liquidity crunch in the market.

Even the Union government has reluctantly recognised the same. The April-June quarter of 2019 witnessed only 5 per cent GDP growth, the lowest in six years.

Following criticisms from the corporate sector, Finance Minister Nirmala Sithraman announced a slew of fiscal stimulus measures and merger of public sector banks to address the issue.

While stimulus soaps may help tackle the demand slump in the short-run, the lack of a strategic approach in policy is apparent.

A look at the history of post-Independence economic management would show that economic crises have often played a catalytic role in bringing much-needed change in economic policy-making.

In that sense, both the current domestic macroeconomic scenario and the global geo-economic dynamic of the trade war have created room for policy maneuvering, particularly as inertia and tweaks are no longer viable.

These actually offer scope for the implementation of long-overdue structural reforms.

In the past few days, numerous economists have taken to print and digital media to debate the nature of the slowdown (structural v/s cyclical) and have suggested reform measures.

However, I would like to focus on the reform measures outlined in the Shenoy Report of 1966, which remain relevant today.

Bellikoth Raghunath Shenoy was among that rare breed of dissenting economists when socialism was in vogue.

Today, he is best known for his Note of Dissent to the memorandum submitted by the panel of economists in preparation for the Second Five-Year Plan.

Less known, however, is the report he prepared on economic trends and reform measures in Sri Lanka (then Ceylon) on the government’s invitation.

The report focussed on the three Ps – Production, Prices and Balance of (P)roduction. The balance of payment part of Indian economy already has seen the light of reform in 1991 and the Indian rupee is now pegged to a floating exchange rate.

However, several other measures in this report remain unheeded till date in India.

In the Production section, Shenoy diagnosed a decline in capital formation as the single biggest cause of economic stagnation in Sri Lanka, which is relevant for India today.

As the debt-equity ratio and trend towards de-leveraging reveal that the organised private sector is not interested in new investment. Shenoy argued in his report that capital formation was adversely affected in Sri Lanka due to the decline in savings.

He blamed the socialist policy of subsidised consumption that cut into savings. Interestingly, something similar is playing out in the Indian context too as the household savings are being mopped up by the combined portfolio of state borrowings.

It would have adverse implications for capital formation. Shenoy’s remedy lies in generation of saving by cutting down on wasteful expenditure.

In the wake of the overblown fiscal deficit that has been kept off the books by creative tinkering of the North Block babus, his suggestion definitely merits attention.

Shenoy further laid down a coherent strategy for the phased elimination of subsidies. He argued that the poorer economies, which are struggling to develop, can ill afford to follow the example of the UK and other “welfare” states.

Instead of various food subsidies provided to poor households, he advocated a free market in foodgrains coupled with direct cash transfer for each beneficiary amounting to the prevalent per-capita subsidy expenditure.

The cash subsidy transfer instead of PDS would curtail wasteful expenditure and the inflow of PDS-freed grains into the market would lead to a decline in prices.

Of course, in India’s context, the curtailment of PDS system needs to be followed by allowing free market in grain trade so that farmers might also be able to earn a profit even when grain prices decline.

For the lower-income group consumers, who stand to lose out from the cash transfer scheme, a shift to cheaper food substitutes would be viable. It should also be pointed out that the leakage in the current PDS mechanism and the byzantine bureaucratic apparatus do not make things better for the marginalised sections.

Direct cash handouts are not only more effective in delivering food security by avoiding leakage, but also come with the freedom to make decisions at an individual level by the poor.

Shenoy’s other very relevant proposal was the privatisation of state enterprises. His analysis succinctly captures the ill management of PSUs:

A recent analysis of the state of Indian PSUs provides an empirical bolster to Shenoy’s prescient analysis. The gravity of the situation is captured in the following sentence:

State PSUs are losing roughly Rs 218 crore per day and the clamour of vested interests — over-bloated salaried employees and misplaced ideologues — leads to wastage of taxpayers’ hard-earned money. Further, these enterprises misallocate scarce capital, and result in direct loss to marginalised poor in terms of opportunity cost; every paisa spent on keeping PSUs functional is not spent on primary education or healthcare.

Strategic disinvestment as pursued by the Vajpayee government would lead to efficient management of companies as well as filling up of revenue coffers, which could be used for unconditional cash handouts or to control the fiscal deficit.

Finance Minister Nirmala Sitharaman’s June 2019 budget announcement drew flak for the imposition of FPI surcharge and angel tax in a bid to raise revenue. It is usual for the government to succumb to the temptations of increased revenue at the cost of private income.

Shenoy opposed such moves in his report on the ground that heavy taxation eats into savings in the hands of individuals and companies, saying: “Taxation destroys potential national savings into a bonfire of public consumption.”

He further argued that the “same amount of capital in the hands of the government adds to the national product a fraction of the additions by the private sector.” Besides, more money in the government’s hands mostly leads to wasteful expenditure on populist schemes due to political pressure.

For Shenoy, the recipe for economic development was a high savings rate combined with lower taxation.

Both these factors, as it turns out, played a key role in the economic turnaround of China and South-East Asian countries.

The fact that Shenoy’s 1966 reform measures are relevant for policy-making in 2019 India is a testament to both the sheer genius of the economist as well as to the failure of the political class to pay heed to evidence-driven policies.

However, the constant repetition of the reform agenda is meant to amplify the voice of reason in the hope that it is heard. After all, Dr Shenoy deserves no less than that.