Modinomics: More About Cautious Optimism Than Impulsive Pessimism

The number of opinion-editorials that have attacked the government on its economic policies has been growing. Some of them have been unnecessarily personality-driven rather than analysing the facts on the table. The gross domestic product (GDP) for the quarter has reduced to 5.7 per cent, the Index of Industrial Production (IIP) has contracted by 0.1 per cent, and the broader impact of demonetisation and the goods and services tax (GST) has also had its effect. While these numbers signify a trend that the government needs to act upon, I argue that this is cyclical and that India is far better, structurally, than it was many years ago. As an extension, I also provide a perspective on the benefits of this economy too.

It is important to get a perspective on all the economic numbers that are floating around to understand the progress that we have made since 2014. That year, there was a reduction of GDP for 12 quarters in succession; the inflation was increasing for 24 months at a stretch with an average of 10.4 per cent (2009-14) and a peak of over 11 per cent at one point. There was significant policy paralysis at the centre with a slew of corruption cases against the government. On top of all this, there was inertia both at the centre and in the states as far as key reforms were concerned.

Fast forward to 2017 – our GDP has been growing significantly over the last few years, making us one of the fastest-growing economies in the world, with praise from the likes of the World Bank and the International Monetary Fund (IMF) (discrediting Yashwant Sinha’s mention of 3.7 per cent as the actual GDP). The World Bank’s ‘Access to Business’ rankings have rated us 30 points ahead of our last year's position – the single largest shift made by any country in any year. Inflation has been tamed, and the average inflation rate has been around 5.5 per cent from 2014-17, and the amount of foreign direct investment (FDI) has been at a record level of $160 billion.

In fact, according to this piece, the data suggests that the incomes of the poor have risen at a much faster pace since January 2015 after the demonetisation exercise. The August and September numbers for the economy are much improved – there has been an increase in the sale of two-wheelers, commercial vehicles and tractors and an improvement in power generation in the steel industries, among others. These cyclical numbers are bound to keep changing, and they cannot be a benchmark for an assessment of the entire Modi term thus far.

One has to use the cyclical numbers over a period of time to gauge trends in an economy rather than go overboard over quarterly numbers. For example, the quarter-over-quarter (Q/Q) numbers must be accompanied by sectoral growth, external macroeconomic trends or effects and similar growth trends over the last few years, among other things. In addition, there has to be a perspective on what the government has invested in during this time, either through reforms or other measures. A Q/Q measure in isolation is a sign of ignorance more than anything else. More importantly, there has been a fundamental shift in how the National Democratic Alliance (NDA) government has approached economic policy and therein lies the reason why we are in safer hands now.

The fundamental difference has been that of implementing systemic structural reforms rather than over-the-layer intangible reforms which do not affect the core functioning of the state. These structural reforms generally are tedious, have short-term pain and cause a lot of flux in the economic functioning of the country. An example of this case has been the structural reforms in Chile from 2015. As mentioned in this IMF paper, economists have argued why there would be short-term shortfalls in GDP, productivity, and so on, but there would be long-term gains once the reforms have been completely implemented.

In the Indian context, the Modi government with its huge political mandate has been brave and decisive in some of the major reforms involved. For example, the demonetisation exercise and the GST are two giant reforms that will have a significant impact on the short-term economy. While the verdict on demonetisation is still ongoing, besides its other benefits on terror funding and black money, it has ensured that the formalisation of the economy has been accelerated to a large extent. This has a significant impact on the way the economy functions in the long run. For example, it forces businesses that have never paid their taxes to get into the tax net, albeit in a complicated manner.

The same goes for the GST. Despite its initial complexity, which, of course, needs to be addressed, the potential of the world’s largest single market is too lucrative for us to ignore or foresee. The conversation needs to move towards how to reduce complexity rather than whining about the implementation of the GST. The bankruptcy law is another example of a structural reform which has serious ramifications for how businesses function. It provides a significant shift in how companies or businesses operate, and hence short-term challenges will have to be dealt with in order to enjoy the long-term benefits.

During the United Progressive Alliance (UPA) years, the major reforms involved either welfarism at its best through the Mahatma Gandhi National Rural Employment Guarantee Act, 2005, and others, or firefighting the challenges faced by the macroeconomic picture or transparency-related issues in governance. To my mind, the UPA-II barely executed anything that was structurally significant — in terms of reforms, it could be due to delayed legislation or otherwise, but the fact that they didn’t have the issues associated with structural reforms is an important point.

Therefore, the argument using cyclical GDP data for a quarter doesn’t fly compared to the previous governments. For example, the political argument against demonetisation is also null because of Modi's big electoral wins (Uttar Pradesh) after demonetisation. Does it mean that the NDA government has no challenges? Of course not.

The fundamental challenge for this government has been raising private domestic investment; it needs to rise for job creation to accelerate. One look at the gross fixed capital formation (GFCF)-to-GDP ratio and the quantum of investment from the private sector would show a steady decline from 2011 onwards. Not only has this not been addressed, it has been largely ignored by the current establishment since 2014 when it was already an issue. Also, the high interest rates that the Reserve Bank of India (RBI) has maintained, has been a big issue for small and medium enterprises to accept credit for finance.

As this writer articulates here, schemes such as Mudra need to be hyphened off into a larger entrepreneurial bank to get away from the behemoth that the RBI is. Many economists have argued for the RBI monetary committee to reduce rates to boost investment since the inflation is well under control too.

The second big challenge, which is intertwined with the first, is that of job creation. The frustration with the Modi government has a lot to do with this, as young people are finding it more difficult to find jobs. There has to be a structural shift in accelerating employment for young people, and that has to be the number-one focus for the new economic advisory council headed by Dr Bibek Debroy. It is imperative that skill development and jobs take precedence over everything else in the run-up to 2019 for the Modi government.

In retrospect, there is no denying that the Indian economy needs to be overseen with more diligence and with greater emphasis on certain key areas such as boosting private investment, jobs and productivity across sectors. However, these challenges are cyclical in nature and can be overcome by measured governmental response. To think of this as an economic crisis is not only naïve but an ignorant understanding of macroeconomic trends.