Welfare Without Growth Can Only Go On For So Long And Not More 

It is by far well recognised that the economy is in trouble, and that growth in the first quarter of this financial year is likely to be well below 6 per cent. The Union Budget tried to address some of the challenges that our economy faces, and thus recovery in the third quarter looked likely but with global growth slowing there is a lot that we need to get right.

There are two questions regarding the recent economic slowdown that immediately come to mind. How did we get here, and what do we need to do to ensure economic recovery? Most commentators have attributed the economic slowdown to either demonetisation or the introduction of goods and services tax (GST), but contrary to popular belief, their impact on growth was muted.

In fact, in a joint paper with Dr Surjit S Bhalla, we found evidence of no negative impact of demonetisation on marketable surplus. Another important factor is that for the first quarter of 2018, the growth rate was at 8 per cent and this was after demonetisation and the GST but by the fourth quarter of 2018 it had fallen to 5.8 per cent. Therefore, we need to investigate the reason why our growth faltered in 2018 financial year.

Throughout 2018, multiple articles were written on Reserve Bank of India’s (RBI’s) inability to forecast inflation which subsequently led to errors in Monetary Policy Committee’s (MPC’s) decisions. A likely consequence, our real interest shot up as the RBI deviated from its own target of real interest rates. What followed was a slowdown and commentators claiming vindication as they ignored what was happening on the monetary side of our economy.

There was an error that was made by the government and it was in terms of accepting the monetary framework that wasn’t suitable for a developing country. The error was followed up by an illusion that it was successful in lowering inflation levels in the economy. Yes, inflation was muted but it wasn’t because of the MPC or because of our interest rates policy; it was because of muted commodity prices along with a departure from high increments in minimum support prices (MSPs) during the United Progressive Alliance (UPA) era.

There’s no denial that the economic performance between 2014 and 2018 was exceptional as we had favourable macroeconomic fundamentals, high growth combined with low inflation despite two successive droughts.

Therefore, Modi 1.0 was great in terms of macroeconomic stability which ensured adequate micro-delivery of basic goods such as toilets, LPG etc. Fast forward to 2019 and global growth is slowing just as India, but our slowdown has little to do with external factors but more to do with domestic issues that need to be adequately resolved.

Some of these issues require deep structural reforms and the Narendra Modi government has a track record of delivering them so we shouldn’t be too worried on this front. What is concerning is that on labour reforms we haven’t seen actual reforms but mere repackaging and aggregation of existing reforms.

This is unlike the Gujarat model and it reflects an urgent need to build consensus on critical reforms. Most of these reforms including land and labour have to be subsequently done at the state level but with a major proportion of the states being governed by Bharatiya Janata Party (BJP), it has a once in a lifetime opportunity to truly kick start India’s manufacturing revolution.

While structural reforms are important but they’re likely to have an impact only in the long term and in the long run we are all dead. This phrase by John Keynes should serve as an important reminder to our policy-makers that we need urgent measures to revive our economic activity. The budget was an excellent opportunity to achieve the same but unfortunately, it was heavy on long-term solutions and, therefore, a missed opportunity.

I had termed the budget as ‘baby steps: but in the right direction’, however, recent events have helped me further understand that the baby steps are far too small. To wait for another six months to fix some of these issues is only likely to cause irreparable damage to the ‘animal spirits’ of the private sector and, therefore, we need to get down to fixing the economy as we correct our past mistakes.

Ironically, while the budget talked about revival of ‘animal spirits’ we have witnessed the exact opposite owing to our misguided taxation policies. Unfortunately, there’s no reversal or resolution of issues that have been highlighted by many over subsequent weeks following the budget.

This has been in contrast with the proactive approach of the government in its previous tenure as it resolved all teething troubles related to the GST. Due to the lack of resolution or reversal of issues related to applicability of surcharges on trust, we have damaged investor sentiment, and this is visible with foreign portfolio investors (FPIs) withdrawing their money from Indian markets.

Similarly, it is a no brainer that the non-banking financial company (NBFC) crisis or the non-performing assets (NPA) crisis has had an adverse impact on credit offtake over the last couple of years. One of the mistakes made was to recapitalise banks slowly thereby prolonging the crisis.

This, at a time when the interest rates were being reduced at a slow pace further made matters worse. A collateral damage in this entire process was our inability to differentiate between genuine business failures (due to economic downturn or unbearably high cost of capital) from cases of frauds. While the crisis is largely resolved, lowering the cost of capital will benefit some of the leveraged sectors thereby expediting the process of NPA resolutions.

While the worst of the crisis in banking space is over, we have the NBFC crisis right in front of us with the IL&FS and DHFL. It would be wise for the government to ensure it facilitates liquidity and helps NBFCs match their assets and liabilities to ensure that the sector continues to provide credit. The sharp slowdown in 2018 occurred partly because in the third and the fourth quarters, NBFCs faced severe liquidity issues thereby curtailing credit. No surprise that consumption growth slowed over this period, especially automobiles.

All is not well with the economy and focusing on increasing tax revenue to meet developmental objectives will not fix it. Former finance minister P Chidambaram tried it during UPA-2 and we all know what followed. Reduce the tax rates to ensure corporates have more profits to invest and to deleverage.

At the same time, reverse the surcharge or offer a resolution to the issue of its applicability on trusts. Such measures will revive investor confidence, boost economic growth and lead to higher revenue mobilisation. Further, it’s about time we start reducing our small savings rate on an aggressive basis while the RBI should be aggressive in reducing interest rates. We have to bring our cost of capital down to ensure revival of economic activity in the short run.

It is important for the policy-makers to realise that to fulfil the promise of development, they need resources and merely redistribution or higher taxes will not help them in achieving the same. What is genuinely required is growth because only when the cake is large enough, we will be able to ensure that everyone gets adequate amount of it.