Faced with severe challenges to the economy, the government has proved to be clueless and timid

P Chidambaram

The so-called tax concession given to the income tax payer in the lower brackets has cluttered the tax structure and created confusion.

Budget 2020-21 was presented on February 1, 2020. It made the headlines and was the subject of editorials on February 2 but, on the next day, it practically vanished from the front pages of newspapers and from television channels. It was like a movie that bombed on the first day.

The BJP, the Prime Minister and the Finance Minister have to blame themselves. They cannot blame the Chief Economic Adviser (who gave some sound advice in the Economic Survey) or the economists and the businesspersons who met the PM for pre-Budget consultations. There were many ideas on the table. Reflecting the buzz in the markets, I had, in my column of January 26, listed 10 things that the FM could do in the Budget.

If the FM did not heed the advice of the CEA or the economists or yield to the demands of businesspersons, it was because of the following reasons:

1. The government is in denial

The government has not accepted that demonetisation and a flawed GST were monumental mistakes that killed MSMEs and destroyed jobs. It has not acknowledged that the slowdown is due to declining exports, instability in the financial sector, inadequate credit supply, lower household savings and reduced consumption, collapse of mining and manufacturing, and pervasive uncertainty and fear. Unfortunately, the FM made no reference in her speech to these negative features of the economy.

2. The government’s assessment of the state of the economy is hopelessly wrong

The government believes that the slowdown of the economy is due to cyclical factors and the upturn will happen if they do more of the same — scrounge for money, put more money into on-going programmes, and announce new programmes. If the causes of the slowdown are more structural than cyclical — as many economists believe — the government has virtually foreclosed the options it had to revive the economy.

3. The government’s ideological pre-dispositions are obstacles to revival

The government believes in outdated philosophies like protectionism, import substitution, a ‘strong’ rupee etc. It does not believe in the multiple benefits of external trade and seems to have given up the effort to find ways to boost exports. It has embraced the retrograde idea of increasing import tariffs. It also appears reluctant to let the rupee find a more realistic level. Given these pre-dispositions, the government finds itself short of solutions.

4. The government is unwilling to reverse measures that have deepened the distrust between the government and business

The government has criminalised many economic laws. It has conferred extraordinary powers on even the lowest-rung officers of the tax-collecting departments and the investigating agencies. Tax collection has become tax terrorism (remember V G Siddhartha). The process of contesting or paying the taxes that are demanded — the process itself — has become the ultimate harassment. The Charter of Rights of Taxpayers promised by the FM has provoked a cynical reaction — why doesn’t the government simply withdraw the carte blanche given to the authorities and agencies?

5. The government has proved itself to be an incompetent manager

From demonetisation to GST, from Swachh Bharat Mission to electrification of homes, from Ujjwala Yojana to UDAY, every programme has serious shortcomings. Unfortunately, the government lives in an echo chamber and hears only adulatory responses. Hence, while humongous amounts of money have been spent on these programmes, the outcomes have been unsatisfactory. The administrative machinery lacks the capacity to improve the implementation or report the true outcomes.

Therefore, there is no surprise that the FM settled for a lacklustre Budget, modest nominal growth of GDP and misplaced optimism about tax revenues. While nominal GDP is estimated to grow at 10 per cent, gross tax revenues are estimated to grow at 12 per cent — an unlikely outcome. Further, the estimated revenues were distributed among a number of programmes — good and bad — as a result of which there was little scope to allocate more funds to programmes that would have ensured that more money reached the hands of the poor quickly. Funds have been unspent in the current year or slashed in the next year for MGNREGA, the Mid-day Meal Scheme, food subsidy, PM Kisan Samman etc. I do not foresee a rise in rural incomes/wages or household consumption.

The so-called tax concession given to the income tax payer in the lower brackets has cluttered the tax structure and created confusion. The estimated benefit of Rs 40,000 crore is not certain and, any way, too small to be impactful.

Nor is there any incentive that will boost private investment. The abolition of DDT has merely shifted the burden of the tax from the company to the shareholders. Besides, when capacity utilisation in manufacturing is at about 70 per cent (thermal power generation is at about 55 per cent of installed capacity), there is little scope for new investment.

In sum, the FM has not addressed the needs of a demand-constrained and investment-starved economy. Nor has she appreciated the multiplier effect of boosting exports. She was compelled to rely on one engine — government expenditure — but that engine too is short of fuel and the spectre of fiscal instability looms over the government. She has also ignored the two most pressing issues — massive unemployment and closure of MSMEs.

Faced with the most severe challenges to the economy in recent years, the self-proclaimed strong and decisive government has proved to be clueless and timid.

A Brief Exercise in Not Taking the Economic Survey 2020 Seriously

S. Subramanian
This is a quick summary review of the latest Economic Survey (2019-20). I have to admit that this quickly-written assessment is a product of an equally quickly-read Survey. If I have not quite pored over it, it is because I found no evidence in the Survey to suggest that it is a document that was intended to be taken seriously – solemnly perhaps, but not seriously. Under the circumstances, I hope I will be forgiven for having spared myself the ordeal of a detailed study of the Survey, and the reader the even greater ordeal of a detailed review of it. Hence this considerately brief commentary.

The Survey is in two volumes, Volume 2 being given over to a purported assessment of the state of the economy, and Volume 1 to the—ah—philosophical perspective guiding it. As far as one can tell, the Vision directing the enterprise seems to be inspired by an infatuation with the perceived virtues of wealth creation and the market. These virtues are seen to be embedded in our civilisational origins (there is much talk of Kautilya and the Thirukural in this tract), and they are extolled with a somewhat startlingly passionate ardour for freedom of the market and against intervention by the government.

In the event, Volume 1 reads like a bewildering advertisement of ancient wisdom seeking and finding endorsement in an essentially rudimentary business school view of the world. This combination of ideas and orientations, executed in somewhat individualistic prose, is inspiring—or at least weird if, like me, you are an elderly codger groping in the dark, and old enough to remember that this country once had a CEA of the likes of Ashok Mitra.

And when you encounter reference to our ‘dalliance with socialism’ (presumably in the dark ages before this New Dawn), then things begin to fall into place a little more clearly: you are enabled to see that if the ‘democratic’ and ‘secular’ aspects of our republic, as vouchsafed in the preamble to our constitution, are currently under a new fix, then so is its ‘socialist’ aspect. That, regrettably, is when the jaw starts sticking out and you begin muttering to yourself.

Not that that’s of much help in enabling you to understand why the Survey believes that there is no basis to the criticism that recent growth rates under the NSO’s revised methodology might have been overestimated. Yes: there is actually a chapter in Volume 1 titled ‘ Is India’s GDP Growth Rate Overstated? No!’ All that stuff on civilisation and culture and tradition must have been infectious, because when I encountered the chapter, I was reminded of that old Tamil saying: ‘my father is not in the granary’ (this being the young boy’s defensively blurted declaration in the story about the debt-collectors from whom the lad’s father was hiding).

In the bibliography to the chapter, I found references to quite a few articles taking issue with Arvind Subramanian’s recently expressed reservations on growth rate estimates, but one will search in vain for any engagement with the work of R Nagaraj, the most consistent and meticulously careful commentator on the subject. Just saying.

Finance minister Nirmala Sitharaman is flanked by junior finance minister Anurag Thakur as she arrives to present the budget in Parliament in New Delhi, February 1, 2020. Photo: Reuters/Altaf Hussain

The best is reserved for the last chapter of Volume 1. The chapter, titled ‘Thalinomics’, is an affecting reminder of the Survey’s continuing concern, first reflected in its 2018-19 number, for the common man: ‘What better way to continue this modest endeavour for forcing economics to relate to the common man than use something that s(he) encounters everyday—a plate of food?’ In this cause, we are treated to an extraordinary exercise. Vegetarian and non-vegetarian thalis are constructed and costed in terms of the quantities and prices of their respective ingredients.

A linear trend line for the cost of a thali at current prices is fitted on price data from 2006-07 to 2015-16, from which point in time the price of the thali tends to fall away from the trend line. The difference between the trend (‘counterfactual’) price and the actual price in 2019-20 is calculated, and annualised estimates of the difference—for both a vegetarian and a non-vegetarian thali—are computed and presented as gains to the common man from benign government policy on thali prices: these gains, one understands, are notional estimates of savings arising from things being not as bad as they might have been under a particular, different scenario. The greatest good that can be done to the common man, it appears, is to invite him to count his blessings, considering that things might have been a good deal worse than they are.

Having said this, there is something else in the numbers put out on thalis by the Survey which seems to have quite completely escaped its authors. From Figure 1 (‘Thali Prices at all-India Level’) of Chapter 11, it appears that the cost of a vegetarian thali in 2019-20 is in the region of Rs. 23, and of a non-vegetarian thali, Rs. 37. With weights of 0.3 and 0.7 for vegetarian and non-vegetarian thalis respectively—these are the population proportions of vegetarians and non-vegetarians in India—the weighted average cost of a thali for 2019-20 might be taken to be in the region of Rs. 32.8. The Survey allows for two thalis a day per person, which works out to Rs. 65.60 as the cost of food per person per day.

The Tendulkar Committee poverty lines favoured by the Niti Aayog are Rs. 27 (rural) and Rs. 33 (urban)—or, crudely, say, an average of Rs. 30—per person per day at 2011-12 prices; allowing for a 150% rise in prices (which is roughly what is displayed by the Consumer Price Indices of Agricultural Labourers and Industrial Workers) between 2011-12 and 2019-20, the poverty line in 2019-20 at current prices would be of the order of Rs.45—which is less than 70% of the Rs. 65 (according to the Survey’s own estimate) that would be needed to avoid hunger! That is to say, a person with an income that is 144% of the official poverty line can keep hunger at bay only by completely emptying out his pockets. Thalinomics, in short, shades off into Khalinomics. My apologies, but as indicated earlier, the mood and language of the Survey tend to be painfully catching.

As for Volume 2, well, it doesn’t always quite tally with what a number of economists have read into recent trends in the economy. No doubt it is benighted, if not downright sinister, to entertain the thought that we are looking at a profoundly demand-constrained downturn in the economy, marked by serious rural distress, depressing tendencies in manufacturing output and exports, unprecedentedly high levels of unemployment, opaque estimates of the fiscal deficit, and governmental suppression or/and criticism of data sources that paint an unflattering picture of the economy.

The Labour Force Participation Survey was released only after the elections, and no doubt it would be sensible to wait for the budget to be presented before releasing the NSO’s Consumption Expenditure Survey for 2017-18, the leaked report for which presents a sorry tale of consumption downturn between 2011-12 and 2017-18. As for what the long-term term effects of demonetisation or the continuing impact of GST on the economy might be, why delve into recent history when we have the comforts of ancient history to see us through? Even the IMF and the World Bank, not to mention various credit-rating agencies, have downgraded projected growth beyond what the Economic Survey will do.

And why not? This Survey is about wealth and entrepreneurship and free markets and privatisation, not about poverty or inequality or public employment schemes. The philosopher P.G. Wodehouse frequently reminds us of the girl Pollyanna who was given, at all times, to being ‘glad, glad, glad’; and like his immortal character Gussie Fink-Nottle, we too must set our faces against pessimism. That would be in the spirit of the Economic Survey, which has no use for the low opinion of his fellow-humans’ interest in their own wellbeing that a scurvy fellow like David Hume (unlike Kautilya, apparently) entertained. Indeed, the reader is exhorted along the following lines in the Preface: ‘We hope readers share the sense of optimism with which we present this year’s Survey.’

In one of his essays, Albert Camus describes a brutal boxing match which is preceded by the soothing strains of a violin. He calls it ‘the sentimental music before the massacre.’ For all that the reader might have been led to believe otherwise from this review, the Economic Survey is just like that. It is the sentimental music before the massacre.
 

For on the day after came the budget, with its distressingly inseparable twin, the budget speech.

The author is an economist, independent researcher, former National Fellow of the Indian Council of Social Science Research, and a retired Professor of the Madras Institute of Development Studies.

Budgeting for jobs, skilling and economic revival

Ram Singh
The forthcoming Union Budget will determine whether India’s economic engine gets the steam needed for a rebound, or the current economic situation becomes even worse. Not just the future of the economy, the future of the country’s youth depends on the Budget.

The unemployment rate at 6.1% (Financial Year 2017-2018) is the highest in 45 years. The rate for urban youth in the 15-29 years category is alarmingly high at 22.5%. These figures, however, are just one of the many problems, as pointed out by the Periodic Labour Force Survey. The Labour Force Participation Rate has come down to 46.5% for the ‘15 years and above’ age category. It is down to 37.7% for the urban youth. Even among those employed, a large fraction get low wages and are stuck with ‘employment poverty’.

Structural factors
The prolonged, and ongoing, slowdown, is the main reason behind the depressing employment scenario, though several structural factors have also contributed to the situation. The GDP growth for the second quarter of Financial Year 2019-2020 is 4.5%, the lowest in the last six years, for which a decline in private consumption and investment are the factors primarily responsible. The aggregate investment stands at less than 30% of the GDP, a rate much lower than the 15-year average of 35%. The capacity utilisation in the private sector is down to 70%-75%.

While the structural factors need addressing, in the interim, the Budget should also focus on reviving demand to promote growth and employment. Schemes like PM-KISAN and Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) are good instruments to boost rural demand. It is really unfortunate that in the current fiscal year, a significant proportion of the budgetary allocation for PM-KISAN will go unutilised. Farmers and landless labourers spend most of their income. This means that income transfers to such groups will immediately increase demand. Further, rural India consumes a wide range of goods and services; so, if allocation and disbursement is raised significantly, most sectors of the economy will benefit. And, the payoff will be immediate.

Besides, rural unemployment can be reduced by raising budgetary allocation for irrigation projects and rural infrastructure like roads, cold storage and logistical chains. These facilities, along with a comprehensive crop insurance scheme, can drastically increase agricultural productivity and farmers’ income. Moreover, by integrating farms with mandis, such investments will reduce wastage of fruits and vegetables, thereby leading to a decrease in the frequency of inflationary shocks and their impact.

Boosting urban employment
In urban areas, construction and related activities are a source of employment for more than five crore people; across the country, the sector’s employment figures are second only to those of the agriculture sector. These projects, along with infrastructure, support 200-odd sectors, including core sectors like cement and steel.

However, due to the crisis in the real-estate and infrastructure sectors, construction activities have come to a grinding halt. At present, many real-estate projects are caught up in legal disputes — between home-buyers and developers; between lenders and developers; and between developers and law enforcement agencies like the Enforcement Directorate. The sector has an unsold inventory of homes, worth several lakh crores.

Even worse, multiple authorities — the Real Estate Regulatory Authority (RERA); the National Company Law Tribunal (NCLT); and the many consumer courts — have jurisdiction over disputes. Consequently, restructuring and liquidation of bad projects is very difficult, and in turn, is a main source of the problem of Non-Performing Assets faced by the Non-Banking Financial Companies.

To revive demand for housing, the Budget can raise the limit for availing tax exemption on home loans. The ₹25,000-crore fund set up by the centre to bailout 1,600 housing projects should be put to use immediately. The funds should be used to salvage all projects that are 80% complete and not under liquidation process under the NCLT. Several additional measures can also help. For example, there should be a single adjudication authority.

The multiplier effects of spending on infrastructure and housing in terms of higher growth and employment are large and extensive. Therefore, the ₹102-lakh-crore National Infrastructure Pipeline (NIP) programme is a welcome step. If implemented successfully, it will boost the infrastructure investment over the next five years by 2%-2.5% of the GDP annually.

Private sector’s risk appetite
Here, the problem is that more than 60% of the planned investment is expected from the private sector and the States. The government does not seem to realise that for private investment, regulatory certainty is as important as the cost of capital. Many infrastructure projects are languishing due to regulatory hurdles and contractual disputes between construction companies and government departments. As a result, infrastructure investment has come to be perceived as very risky. This is the major reason behind non-availability of private capital for infrastructure.

In this scenario, where the private sector has very little appetite for risky investments and State finances are shaky due to low GST collection, the onus is on the Centre to ensure that the programme does not come a cropper. The budgetary support to infrastructure will have to be much more than the NIP projection at 1.11% of the GDP.

Bidding and contracting for new roads, highways, railway tracks and urban development projects is a lengthy process. This is also the reason why several infrastructure-linked Ministries like those for civil aviation and roads have not been able to spend money allocated to them in the current fiscal year. Therefore, rather than earmarking budgetary support for new projects, the focus should be on projects that are currently under implementation so as to complete them as soon as possible. That is, funding should be front-loaded. In addition to creating employment, a timely completion of infrastructure projects will help increase competitiveness of the economy.

The distress among Small and Medium Enterprises (SMEs) is another area of concern. For many products produced by these enterprises, the GST rates are higher for inputs than the final goods. Due to this anomaly, around ₹20,000 crore gets stuck with the government annually in the form of input tax credits. This has increased cost of doing business for SMEs, which employ over 11 crore people.

Next, according to some estimates, there are more than 22 lakh vacancies in various government departments. Such dereliction is baffling when the unemployment among youth is very high.

Job openings that arise in the private sector put a premium on practical skills and work experience. Here, popular perception is that a good job requires a college or university degree. This misperception is the result of failure of the governments to provide affordable and good quality vocational training programmes.

To stop the demographic dividend from becoming a national burden, there is a need to invest heavily in skilling of the youth. Besides, the Budget should give tax incentives to companies and industrial units to encourage them to provide internships and on-site vocational training opportunities. This work experience can be supplemented with teaching of relevant theories. at educational centres set up at district levels. Distance education mode can also used for the purpose.

Ram Singh is a Professor at the Delhi School of Economics

Budget 2020: Hope for the best, prepare for the worst

P Chidambaram
Another year has started, another Budget is round the corner, and another fateful year for the Indian economy.

Since 2016-17, every year has brought surprises and tears. 2016-17 was the year of the catastrophic demonetisation. 2017-18 was the year of the flawed GST and its hurried implementation. 2018-19 was the year when the slide began and the growth rate dipped in every quarter (8.0, 7.0. 6.6 and 5.8 per cent). 2019-20 was the wasted year when the government refused to heed warnings and allowed the growth rate to collapse to below 5 per cent.

Extent of Collapse

It is now pretty clear that

* 2019-20, when the final revisions are made, will record a growth rate of less than 5 per cent;

* that the government’s revenues will fall significantly short of the BE (Budget Estimates) under both major heads (net tax revenue and disinvestment);

* that the fiscal deficit will breach the BE target of 3.3 per cent and will be close to 3.8 to 4.0 per cent;

* that both imports and exports of merchandise will record negative growth over the previous year;

* that private sector investment (measured by Gross Fixed Capital Formation), in current prices, will be about Rs 57,42,431 crore (or 28.1 per cent of the GDP), indicating investor risk-aversion and weariness;

* that private consumption remained sluggish throughout the year;

* that the agriculture sector remained under acute stress and will return a growth rate of about 2 per cent;

* that the job-creating sectors like manufacturing, mining and construction shed jobs in 2019-20, leading to a reduction in total employment;

* that credit growth to industry as a whole, and to the SME sector in particular, will be negative over the previous year; and

* that year-end CPI-based inflation will be over 7 per cent (with food inflation at over 10 per cent), adding to the distress caused by rising unemployment and stagnant wages/incomes.

According to Dr Arvind Subramanian, former chief economic adviser, the economy is in the ‘intensive care unit’. According to Nobel Prize winner Dr Abhijit Banerjee, the economy is ‘doing badly’. None of the observations of critics seems to have worried the government, that maintains that the upturn will happen in the ‘next quarter’! Because of its ostrich-like attitude, the government has rejected every correct remedial measure and has, instead, taken the wrong measures. For example, if taxes had to be cut, the government should have cut indirect taxes; instead it gave a bonanza amounting to

Rs 1,45,000 crore to the corporate sector and got nothing in return in terms of higher investment. The government should have boosted demand by putting more money in the hands of the poor; instead it cut back on the outlays (BE) for MGNREGA, Swachh Bharat, White Revolution and Pradhan Mantri Awas Yojana and may actually spend even less.

PM’s budget: What will he do?

When the Prime Minister met with 12 top businesspersons (without Ms Nirmala Sitharaman or aides), it showed nervousness as well as lack of confidence in the Finance Minister. According to sketchy reports in the media and hints dropped by some of the participants, the following are possible in the Budget that will be presented on February 1, 2020:

1. A cut in the income tax rates for individuals earning up to Rs 10 lakh a year.

2. Abolition or reduction of the tax on Long Term Capital Gains realised after holding the security for two years.

3. Reduction of the rate of Dividend Distribution Tax.

4. A promise to introduce the Direct Taxes Code.

5. Selective, short-term reduction of GST for a few sectors like construction.

6. Increase in the PM-KISAN amount from the current level of Rs 6,000 per year and/or extension of the scheme to more categories of beneficiaries.

7. Large increases in the outlays for defence; MGNREGA; SC, ST, OBC and minority scholarships; Ayushman Bharat (health insurance) etc by over-estimating tax revenues or borrowing heavily.

8. Setting up of one or two Developmental Finance Institutions (DFIs) for providing long-term finance to industry in general and SMEs in particular.

9. A massive disinvestment programme and/or asset monetisation programme with the narrow objective of raising resources.

Economy a Drag

All of the above is in line with the thinking of the government that relies heavily on the corporate sector (for funds), on the middle class (for votes) and on the defence of India (for distraction). Its capacity to think of structural reforms is limited. It has no confidence that the banking system will provide credit. Thanks to its protectionist lobby, it has given up on foreign trade as an engine of growth. It does not wish to curtail the exuberance of the stock markets. It cannot define its relationship with the RBI and determine how the two can maintain financial stability, promote growth and contain inflation.

The economy is not the main concern of the BJP government; it is the Hindutva agenda. On the other hand, the people are concerned with issues tied to economic growth such as more jobs, better producer prices, wages and incomes, relative price stability, access to better education and health care, and improved infrastructure.

It is painfully clear that the people have got a government that has turned the Indian economy into a “drag on the world economy”. That is the damning verdict of the IMF.

Truth about global inequality

Telegraph Editorial Board
The latest Oxfam report, Time to Care, which was published ahead of the World Economic Forum’s 50th annual meeting, has estimated that the top one per cent of people in India hold more than four times the wealth held by the bottom 70 per cent of the population or about 950 million people. All the 63 Indian billionaires put together have more wealth than the total annual budget for 2018-19 for the Indian economy presented by the government. This finding is consistent with the shocking global trends of rising economic inequality. According to the report, the world’s 2,153 billionaires have more wealth than the 4.6 billion people who make up 60 per cent of the world’s population. While hardly anybody would disagree with the fact that some amount of inequality is inevitable in any society or that a modicum of it may actually serve as a stimulus for raising aspirations and hence economic growth, the current levels are completely unacceptable.
The implications of this massive degree of inequality are many, and almost all of them are socially, politically, and economically disruptive. Deep inequalities, more often than not, engender social unrest. People tend to be more intolerant and corrupt in a social ambience that is perceived as unfair by the majority. Typically, the few who are rich and powerful insist on — and fund — a decisive government that cracks down on dissent, tries to divide and rule in an attempt to maintain social stability, and might even try to amend Constitutions to make power more centralized. Inequality becomes an enemy of an open, plural, and democratic society. These trends are being observed in many countries of the world, even though the tolerance limits of people and the tipping points of social instability vary from nation to nation. Another implication of deep economic inequality is that it is biased against women. Among the poor and dispossessed are a disproportionate number of women and young girls. The report suggests that in India it would take a female domestic worker 22,277 years to earn what the CEO of a top technology company earns in one year. It is estimated that women and young girls put in 3.26 billion hours of unpaid work each day. Their contribution to the Indian economy amounts to 20 times the entire education budget of the nation. Finally, on the economic front, if this trend of rising inequality continues, then in just two or three decades the only way to become rich would be to be born rich. The great appeal of market capitalism that allowed equal opportunities for people to work and grow might disappear forever.

The budget should increase spending in rural areas, cut taxes and bring back trust in financial system

Soumya Kanti Ghosh

The Union budget will be presented in the context of an entrenched slowdown that is becoming increasingly difficult to overcome. Coupled with this, the recent increase in inflation (notwithstanding the current methodology) has complicated the budget-making exercise. We believe that this budget could make a substantial difference by challenging the conventional wisdom that does not stand the test of scrutiny.

The primary purpose of the budget is to lay out a receipt-expenditure statement and thereby the fiscal deficit estimates. This year is, perhaps, different as the slowdown has derailed the fiscal arithmetic. Our estimates show that the shortfall might be anywhere between 0.5-0.7 per cent of the GDP in the current fiscal after adjusting for revenue shortfall and expenditure rationalisation.

Given that the government is now facing such a huge mismatch, the fiscal deficit glide path is likely to be recalibrated. But, here lies strong resistance from the votaries of fiscal consolidation, which is echoed in government circles too with independent reports pegging the fiscal deficit estimate at 3.5 per cent for 2020-21. We believe the government must not target a number in FY21 that is not credible and achievable. The growth dynamics suggest that with a nominal GDP growth that could be at 10 per cent, a 3.5 per cent target will result in the absolute fiscal deficit in FY21 being lower than in FY20, and that again will be unachievable.

In this context, the fiasco in FY12 bears mentioning. The government wanted to reduce the fiscal deficit from 4.8 per cent of the GDP to 4.6 per cent. But, in absolute terms, the difference between the fiscal deficit in FY11 and FY12 jumped four times as the 3.3 percentage point collapse in growth was not factored in. Thus, the temptation of having a 3.5 per cent deficit target in the budget must be avoided at any cost as we face a similar growth slowdown. Instead, the fiscal deficit must be kept only at a marginally lower level or the same level in FY21 (vis-à-vis FY20). We must focus on growth. A large fiscal compression in the budget, through a reported expenditure curtailment of Rs 2 lakh crore, could be an unmitigated disaster for growth and will definitely raise the possibility of lack of transparency in the fiscal numbers of FY21 in the eyes of the market.

So, what are the options before the government? First, is the apparent trade-off between tax concessions and stimulating the economy by giving a fillip to the rural economy. There is now an apparent consensus that with only 4 per cent of people paying income tax, a tax concession might be a wrong approach to stimulate demand. There are, however, two fallacies with this argument. First, even when 2 per cent of the people paid income tax during 2004-08, the Indian economy expanded by close to 8 per cent on average. Second, the 4 per cent population accounted for a significant part of overall consumption, and in FY19, the overall gross taxable income of this population was Rs 46 lakh crore, which is 40.8 per cent of the overall private final consumption expenditure. Hence, it is possible to tweak both the slabs and the tax rates to increase consumption, which is key to growth. The only issue with such tax changes that could make the government wary is the revenue foregone. Our estimates suggest that a 5 per cent cut in taxes across income buckets can result in a revenue shortfall of only 0.5 per cent of GDP.

Second, the idea of a rural push through PM-KISAN scheme is understandable, but efforts must first be made to cover all the farmers under the scheme. It is quite puzzling that despite 92 per cent of the land records being digitised, PM-KISAN still covers only half of the eligible beneficiaries. As was promised in the 2018 budget, a tenancy certificate must be issued to every tenant farmer — 70 per cent of farmland is cultivated by tenant farmers, who are not entitled to any benefit because they do not own land. Third, the government should think about increasing the Rs 6,000 yearly amount in a calibrated manner (say Rs 500 per year over the next four years) as the incremental cost will be negligible. As this will create a feel-good factor across the farming community, why not start from this year itself?

Third, the government must think about the trade-off between tax adjustment and incentivising savings. When the government notified an increase in the public provident fund (PPF) limit by Rs 50,000 to Rs 1,50,000 in August 2014, its impact on household savings was enormous. For example, an increase in the 80C limit by Rs 1 lakh to Rs 2.5 lakh for individual households will lead to additional savings of more than Rs 2 lakh crore as compared to a revenue and interest foregone amount of Rs 40,000 crore. The question is thus of incentivising consumption, or savings or both?

In this context, let me also comment on the repeated fallacies of commentators who advocate in favour of fiscal conservatism on the ground that entire household financial savings are being used to finance government borrowings. The numbers suggest otherwise. Of the Rs 11.2 lakh crore of net financial savings in FY18, total claims on government were around Rs 70,000 crore, while Rs 7.74 lakh crore were claims on insurance, pension and provident funds (assuming FY17 ratios). Household claims on pension, insurance and provident funds are purely savings for the households’ retirement corpus and it is completely naïve to equate such claims as financing government borrowings. The decision of such retirement funds on where to invest their corpus is a purely portfolio-decision, just as is the household decision to investment in small savings.

Apart from such fiscal measures, the budget must announce its intent to bring back trust in the financial system. To this end, a simultaneous recognition of stressed assets of NBFCs and thereafter immediately initiating measures to help them to raise capital by initiating takeovers/mergers if required and giving the rest a clean chit, thereby, increasing the confidence to lend, is required. We must not repeat the mistake we made with banks when we first initiated recognition of bad loans through the asset quality review in 2015, then brought resolution through the IBC law in 2016, and then resorted to recapitalisation in October 2017. The sequence should have been resolution first, and recognition and recapitalisation simultaneously thereafter.

We can also think of forbearance for large NBFCs by deferment of principal repayments by systemically important NBFCs and HFCs. These NBFCs and HFCs can allow similar deferments to their clients. Since interest would be paid during this period, lenders would not make a loss. This should be adequate to get the cash flows from stuck projects going and to ensure the fulfillment of the prime minister’s vision of Housing for All by 2022.

Interestingly, as we write on the budget priorities, the Supreme Court judgment on telcos’ adjusted gross revenues could just about tilt the budget arithmetic in the government’s favour. On the flip side though, this order could lead to significant market disruptions and possibly impact consumption as well.

This article first appeared in the print edition on January 21, 2020 under the title “The deficit bogey”. The writer is group chief economic advisor, State Bank of India. Views are personal.

Hard times for sure

Renu Kohli
The early gross domestic product estimate (GDP) released this month by the national statistical agency assessed India’s growth at 5 per cent this financial year. It is the slowest pace of growth in the last 11 years, the third successive year of deceleration, and the fall in real GDP growth this year is a hefty 1.8 percentage points over last year (6.8 per cent). Still, the official advance GDP numbers were not a

surprise because all forecasters had downgraded much before, as did the central bank last December. In fact, many private analysts expect the growth out-turn to be even lower, below 5 per cent, as consumer spending failed to revive as anticipated in the October-December festival quarter and the steep decline in tax revenues has forced the government to restrict spending to one-fourth of the annual budgeted amounts for various ministries. The real worry is about what lies ahead.

Hard times seem inevitable. As the budget day approaches, all expect the government to respond appropriately to the stretching economic weakness. But rather than taxation and spending changes to stoke demand, it is the reverse or subduing effects of the withdrawal of chunks of expenditure that will play out. A retreat or slower pace of government spending exerts itself through reduced purchases, orders, and contracts whose impact radiates across other segments of the economy. The extent of such drag can be seen by the enormous spending support to growth by the government in recent times: about 45 per cent of the July-September quarter’s 4.5 per cent GDP growth came from such spending that grew an exceptional 16 per cent year-on-year and double its pace in the first quarter of April-June; minus this booster, GDP growth was below 3 per cent. Similarly, government expenditure raced phenomenally at 15 per cent and 9 per cent in the last two years (2017-18 and 2018-19); for 2019-20, estimated growth is a further 10.5 per cent.

Lower this pace and aggregate GDP will feel the pinch. The troubling thought is not only for the remainder of this year, when pressures to make ends meet typically intensify at the end. Government spending is likely to be forced to slow down next year too. This is because of the widening gap in public revenues and expenditures. Spending has expanded significantly in the past two years, especially its current or revenue component; this consists mainly of salaries, interest payments, subsidies and other transfers (for example, schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme, the Pradhan Mantri Kisan Samman Nidhi). At the same time however, tax revenues have trended in the reverse direction, that is, slowed down. This tightens financing of expenditures, the committed component of which is impossible to cut. Tax revenues fell short by Rs 1.65 trillion last year and the deficit is likely to be larger this year — Rs 2.6-3 trillion is the commonly cited range as both direct and goods and services tax collections are hit by the rapid slowing of output. Non-tax sources, that is, divestment and asset sales, have not matched expectations so far. There are frequent reports of frantic dividend revenue-seeking by the government, namely, from oil companies and the Reserve Bank of India; plans of yet another immunity scheme allowing direct taxpayers to declare any additional incomes in the past five-six years without penalty or prosecution, and the recovering of past dues from telecommunication firms for adjusted gross revenue payments, which may be partly paid. The extent of the public revenue shortfall is unlikely to evaporate very fast. At the least, an upswing in activity is essential for higher growth in revenues. But the portents for this are uncertain and underwhelming at this point.

So even as all look towards demand support in the upcoming budget, the government does not have the wherewithal for pleasing booster shots. Over-optimistic revenue projections would erode credibility, as happened last July. Raising taxes in one segment to finance a stimulus for another part will be counter-intuitive in a slowing economic context. Moreover, fresh taxation could invite backlash, further depress sentiment in a replay of last year’s budget. Under these resource-scarce circumstances, public expenditure would have to slow down, which would be a weakening force.

Rising inflation is the next spoiler. The RBI eased policy rates by 135 basis points last year, devoting equal policy attention to ensure that the borrowers benefit from its pass-through via banks and are encouraged to spend more. But the inflationary expectations of households have adjusted quickly to food prices that are rising since mid-2019. Retail food inflation galloped from 3 per cent last August to 14 per cent in December, pushing up overall retail inflation, on which monetary policy is based, to 7.4 per cent. These developments, along with some other factors such as hikes in telecom tariffs, fuels and liquefied petroleum gas, possible fiscal expansion in the forthcoming budget, have injected caution in the otherwise softer interest rate environment. The RBI rested its easing cycle last month, turned more watchful. The bond market has reacted with higher inflation risk premium, keeping the 10-year yield — benchmark for banks’ loan rates elevated.

Many assure the food price rise is temporary; it will pass over, leaving the easier monetary situation unchanged. But matters may not be all that sanguine. If inflationary beliefs of the public get entrenched owing to the persistence of food inflation for several quarters, that

increases the risk of feeding into wages (for example, public servants’ salaries are indexed to retail inflation) and thereon to other prices. This could make things more difficult than at present: high inflation reduces real incomes or purchasing power; instead of additional spending encouraged by lower interest rates, consumers and producers are pulled down by lower disposable incomes and costlier input.

Finally, new or unanticipated risks and shocks surfaced in the past few months from civil disturbances and protests that in turn, elicited disruptive internet shutdowns and prohibitory orders by various state administrations in many parts of India. These hurt consumption and business: for example, several companies explained that their previous quarter sales suffered from store closures, lower footfalls in showrooms and disrupted supplies, last month. Food orders, restaurant visits, e-commerce were affected likewise, according to news reports. Growth in the travel and tourism industry also reduced because of cancellations and cautionary advisories from foreign governments. Output losses caused by internet shutdowns in 2019 (estimated above 100, for about 4,196 hours by Top10VPN, an internet research firm) are calculated about $1.3 billion for 2019, according to The Global Cost of Internet Shutdowns report released earlier this month; this figure is an underestimate, says the report, as the focus was region-wide shutdowns, which tends to exclude many incidents. Further repeats of such shocks cannot be ruled out ahead. It is notable that the influential global risk-assessment consultancy, Eurasia Group, has reportedly placed India as one of 2020’s top geo-political risks.

When growth falls as steeply as it has this year, and the slowing is extended to the medium-term, emerging out of it takes longer and is more difficult because households and firms are more enduringly weakened than in a short-lived, cyclical downswing. And if policymakers lack resources or policy levers to arrest the sliding, a painless recovery is harder to achieve. The current economic situation is precisely at such a confluence — the government can do little by way of fiscal responses, an easing monetary cycle expected to manage the downswing faces uncertain inflationary challenges. Unless fortune unexpectedly smiles, hard times seem inevitable ahead.

Only way is up for interest rates after inflation hits 6-year high

By Paran Balakrishnan

Goodbye interest rate cuts. The leap in headline consumer price inflation to its highest level in nearly six years means the interest-rate cutting cycle is over and that the next interest rate move will be up, say analysts.

While good news for savers, this is the latest piece of bad news for Prime Minister Narendra Modi’s government under whose watch the economy’s been tanking. For finance minister Nirmala Sitharaman, the adverse inflation climate only makes her job of preparing her “pro-people, pro-growth” budget, due to be presented February 1, even tougher.

The government has been pushing for rates to come down further, even though the monetary easing medicine hasn’t had an effect. Financial institutions have been slow to pass on the rate cuts and in any event, businesses are more inclined to hang on to their money and repair balance sheets than make investments when demand’s sluggish. (The extent of how sluggish demand is was highlighted when India’s flagship auto industry reported car sales dropped a record 19 per cent year-on-year in 2019).
Despite a string of cuts in this rate-cutting cycle which began in February last year, economic growth has kept falling with second-quarter growth hitting 4.5 per cent, its lowest in six years. The government now projects Indian economy will expand in the full-fiscal year by 5 per cent, down from 6.8 per cent which would be the lowest pace in 11 years. But privately economists say the growth figure could well be lower with Fitch Ratings, for instance, pegging it at 4.6 per cent, citing “weakening business and consumer confidence.”

Now, throwing a further spanner into the works is accelerating inflation. India looks to be in the embrace of that toxic mix known as stagflation -- defined as slow economic growth, increasing unemployment and rising prices. Traditionally, when an economy is in the doldrums, the remedy is cutting rates. Now, though, it’s virtually certain that the Reserve Bank of India will keep its benchmark policy rates unchanged when it meets next in early February. And inflation could also mean that rate hikes will come earlier than expected.

“The jump in headline CPI (consumer price inflation) to its highest since 2014 almost guarantees that the RBI will leave policy rates on hold at its next meeting in early February. And with core inflation likely to rise over the coming quarters... policy rates will be hiked much sooner than most are expecting,” say Mark Williams, Capital Economics chief Asia economist.

Williams said that the available data for January show that food inflation has yet to ease and, “If we are right in forecasting a rise in global oil prices this year, fuel inflation looks set to rise further as well.” Heading the list of vegetable-inflation drivers are onions (which traditionally make Indian governments weep) Shutterstock

So why does the interest rate-easing party seem to be over? Let’s remember first of all that the central bank’s target for headline inflation is 4 per cent and inflation has only been heading northward of that figure. CPI inflation jumped from 5.5 per cent year-on-year in November to 7.4 per cent year-on-year in December -- a staggering 181 basis-point jump. That is the biggest rise since July 2014.

The rise was broad based but mainly driven by food inflation -- specifically vegetables which are up a staggering 60.5 per cent year-on year. And heading the list of vegetable-inflation drivers are onions (which traditionally make Indian governments weep). The headline figure is the highest it’s been since July 2014. By the way, this upward move was far bigger than expected by the financial markets which expected the December rate to be around 6.7 per cent. There’s also been shocks from the rise in oil prices.

Core inflation, which excludes the volatile movements of food and fuel, is looking more stable, edging up to 3.75 per cent even after mobile phone companies substantially raised subscriber costs and railway fares rose. But economists believe core inflation will also creep higher to around 4 per cent.

“We expect the central bank to switch to tightening mode much sooner than is generally expected. We are forecasting modest rate hikes in 2021 with the first move possible before,” says Capital Markets’ Williams.

Economists figure it’s already a given that the financially strapped government will have to burst its fiscal deficit target in the budget. Adding to the government’s woes on this score are the lower-than-forecast revenue collections. It all means that the government will likely have to leave out any feel-good, economy-boosting income tax cuts.

“The upcoming budget in February would be closely watched for fiscal stance and sector-specific actions. Even so, our estimates suggest inflation will likely remain above 6.5 per cent in the fourth quarter of 2020 and could constrain a rate cut in February,” financial services firm Edelweiss says.

HDFC Bank Chief Economist Abheek Barua says the government needs to put more attention on the agricultural sector as higher food prices have a big driver of the higher inflation via better food stock management to avoid shortages. But there’s a big unknown with the rabi crop. Economists also say that the 45 per cent weightage of food prices in the consumer consumption basket may be unrealistic and needs to be reassessed.

What’s ahead for prices? Well, economists expect inflation to stay high in January as well but say it could retreat in the second and third quarters to 4.7 per cent or a little lower, and then head sharply south to possibly 2-2.5 per cent in the fourth quarter.

And if all this bad economic news wasn’t enough, the slow growth is now having a “visible impact” on job creation, notes the State Bank of India. In fiscal year 2019, India created 89.7 lakh new jobs. “In fiscal 20, as per currently projected, this number could be at least 15.8 lakh lower, the SBI said on January 13.

The Confederation of Indian Industry in its pre-budget recommendations to the government says, “All engines of growth are showing sluggishness – consumption, investments and exports, placing the burden of kickstarting the economy on government expenditure.” The CII adds that, “a flexible, yet prudent fiscal policy is the need of the hour.” That’s a tall order under the circumstances, especially as the government has its plate full on the political front, struggling to control the after-effects of passage of the Citizenship Act.

Impression that government prioritises non-economic agenda over development must be addressed

Written by Amartya Lahiri India is now well and truly in the middle of a socio-economic upheaval. The economy has been weakening for a couple of years now. The social upheaval is new but its seeds have been fermenting for a while. The danger here is that the social and economic sides of an economy are not divorced from each other. Each influences the other and the current quagmire threatens to unleash the worst type of feedback between the two.

The most dangerous smoldering ember that could erupt due to the interaction between the social and economic sides is unemployment. The rising unemployment in the country has been commented upon widely. Less noted is the fact that rising unemployment disproportionately affects the young. Misfiring European economies like Spain, Greece, and others routinely report youth unemployment rates above 25 per cent. This is a social tinder box for a country like India whose median citizen is in the 30s and which is thrusting 10 million new young people to the job market every year. This dynamic, popularly hailed as India’s demographic dividend, can rapidly turn into a demographic curse if the employment situation doesn’t improve. A massive pool of unemployed youth makes for a huge collection of unhappy people, running high on testosterone and anger, looking to vent.

Along with this volatile pre-existing cocktail, we now have the addition of the state strong-arming youth protesters across the country. Each violent police action begets more resentment, protests, and additions to the ranks of protesters. Unemployed youth are fodder in these situations for all sides. The young can provide volume, sound, and muscle with relatively little concern for self in normal times. Lack of attractive opportunities makes this risk-taking trait more acute. Self-preservation is a predilection that affects the middle-aged more since they have more to protect.

So where will the jobs come from? The job creators are entrepreneurs, conglomerates, and multinationals. It is in their nature to take investment risks as long as the returns are high enough. Investment rates in India fell well below 30 per cent a while back. Clearly, the returns were not compensating entrepreneurs for the risk. The recent social upheaval is only adding to the perceived risk. It can only be dissuading more fence-sitters from investing in the economy until the uncertainty ebbs and the situation calms down. But the more investors adopt a “wait-and-see” approach, the worse the job situation will become. The worse the job situation becomes, the greater will be the ranks of the angry youth. This has all the makings of a devastating feedback loop. For the sceptical, the examples of Brazil (28 per cent youth unemployment) and South Africa (58 per cent youth unemployment) should be salutary examples of emerging economies descending into crime, violence, and crisis due to failing to productively (and respectfully) engage their youth.

The government’s focus on the economy is unclear. Through its personnel decisions in the past few years, the central government has signaled its low priority on economic management. The position of Deputy Governor (Monetary Policy) of the RBI lay vacant since July 2019 when Viral Acharya resigned. Despite the fact that he announced his decision to resign back in May 2019, the government only filled the vacancy this week. In the interim, the Monetary Policy Committee was operating without a key technical specialist for seven months. A previous vacancy for Deputy Governor of the RBI also remained unfilled for 11 months before MK Jain was appointed in June 2018.

This is particularly debilitating for the RBI because the government replaced Governor Urjit Patel with someone whose domain competence does not lie in either banking or finance or markets or macroeconomics or monetary economics. To compound matters, the government has chosen as economic advisors two people whose domain specialisation is in markets, banking and finance. They would be far better used in the RBI rather than the ministry of finance, which requires trained macroeconomists.

The choice of personnel in key ministries has been equally confusing. In the latest garnish to this soup of confusion, the prime minister was accompanied by the home minister during pre-budget consultations about the state of the economy with industrialists and economists. Strangely, the finance minister was not included in these deliberations.

The overarching impression all of this has given is that the government has prioritised its non-economic agenda over the development agenda. This has become more glaring over the last 18 months when the government started running out of the low oil price largesse that financed its welfare spending till 2017. Without the fiscal room for more spending and the political will to enact labour and land reforms, the government seems out of ideas. Its only proactive moves appear to be retrograde ones such as raising import duties. More damagingly, it is seen as trying to control the message by refusing to release data. This just makes things worse because people assume the worst.

A few changes are needed immediately. The government needs to announce a clear plan and timeline for structural reforms. Alongside, it has to start staffing technical positions by prioritising domain competence and empowering these hires with policy relevance. Importantly, it needs to pledge its commitment to the integrity of institutions tasked with the regulation of corporations and banks, monetary policy management, data collection/dissemination and law enforcement.

The government also needs to desist from trying to drown out protesting voices with state muscle power. Protests serve as a pressure cooker valve. They preserve order by allowing people to vent. Hope goes a long way, especially for the young. A climbdown from the arrogance of power would be a good way of generating hope.

This article first appeared in the print edition on January 16, 2020 under the title ‘Reset and refocus’. The writer is Royal Bank Research Professor of Economics, University of British Columbia

Government must choose between tax reductions and increasing rural spending

Written by Suvodeep Rakshit
The first advance estimate pegs India’s economic growth at 5 per cent in 2019-20 — the slowest since the global financial crisis of 2008. While one may quibble over whether the actual print may be lower or higher, the cause of the slowdown can be attributed to subdued private consumption and investment activity. And given the current trend of high frequency indicators, not much upside to growth is expected.

The slowdown can be attributed largely to a structural demand problem in the economy along with some cyclical factors. Despite largely stagnant incomes, private consumption, which is the largest driver of growth, has been financed over the past few years through progressively lower savings, easy credit, and certain one-offs such as the Seventh Pay Commission led payouts. The household savings rate has dipped to 17.2 per cent of GDP in FY18, from 22.5 per cent in FY13. And after the recent NBFC crisis, overall credit in the system has dried up as incremental resources from NBFCs to commercial sector were at (-) Rs1.3 trillion in the first half of FY20 compared to Rs 0.9 tn in first half of last year.

The rural economy has been reeling from low wage growth and largely stagnant farmers’ incomes. Rural wage growth has averaged around 4.5 per cent over the past five years, but adjusting for inflation it has been only 0.6 per cent. The rural population, which was dependent on urban real estate/construction has faced headwinds in the recent past with lower private sector investments and a weak real estate sector.

Looking at the key drivers of growth in the short term, there is limited scope for a sharp recovery. The slowdown in private consumption is a structural issue linked to low household income growth. That in turn is linked to the basic problems of low job creation, and stagnant farm incomes. None of these factors are likely to change immediately. Investment is unlikely to rebound sharply given the challenges on both income and balance sheet of the government, private sector, and households. And government consumption, which has been supporting growth over the past few years, remains under stress. The combined Centre and states’ fiscal deficit is close to 6.5 per cent of GDP. Along with an additional 2.0-2.5 per cent of GDP of central PSE borrowings, the public sector is already weighing on the limited domestic financial resources, ruling out space for an aggressive fiscal stimulus.

The government to its credit has shown a clear preference to rely on supply-side measures to support growth. Yet, expectations will be high that the upcoming Union budget addresses the demand side concerns as well. To this end, the government will possibly need to choose between income tax rate reductions, and substantially increasing allocation to the rural sector. Given the narrow income tax base, any sacrifice of the fiscal room would be beneficial only for a limited number of people. Based on filings for the assessment year 2019, out of around 58 million tax filers, only 15 million tax filers had a return income above Rs 0.5 million. Further, the impact on consumption would vary widely depending on the relative gains across income brackets. On the other hand, spending on rural infrastructure and employment (MGNREGA, PM-KISAN, PMGSY) can help alleviate some of the pain in rural areas.

The recovery will depend on the utilisation of the fiscal space, and also the health of the financial sector, especially that of NBFCs. The PSU banks are being nursed back to health, but credit flow from NBFCs to certain segments such as MSMEs needs to pick up.

Addressing India’s long term growth concerns and to push the country into the middle-income group of economies requires a broad-basing of the income and consumption profile. Economic reforms in the past have worked to enhance the capacity of the top few hundred million consumers. The next set of reforms should enhance the capacity of those in the middle and the bottom of the income pyramid.

Further, given the huge infrastructure gap in the country, it is essential that the private sector’s role in infrastructure creation is much more inclusive.

In four key areas of infrastructure — electricity (generation, transmission, and distribution), transport (airports, roads, railways, metros), telecom, and water (irrigation, sanitation, sewage, water supply) — the private sector’s involvement is largely restricted to generation in electricity, inter-city roads, airports in transport, and telecom. The rest are largely in the hands of the Centre, state, and local governments. Policies need to focus on ownership (which is largely government dominated) and pricing (which provides the private sector with a remunerable internal rate of return). It is important to note that creating an enabling environment is to a large extent in the purview of the state and local governments.

Given the degree and nature of the growth slowdown, policymakers should continue to focus on measures that raise the potential growth of the economy. Reforms which increase the productivity of the factors of production, provide an enabling environment for competitive production of goods and services, and ensure steady and substantial growth in purchasing power for a larger section of the population should be the focus. After all, why let a crisis go waste.


(This article first appeared in the print edition on January 10, 2020 under the title ‘Limited scope for sharp recovery’. The writer is Vice-President and Senior Economist in Kotak Institutional Equities.)

How are the fundamentals of the Indian economy?

Udit Misra
On Thursday, after a two-hour-long meeting with a whole host of economists, sectoral experts and entrepreneurs, Prime Minister Narendra Modi sounded sanguine about the Indian economy recovering from hitting a 42-year low in terms of nominal gross domestic product growth rate.

“The strong absorbent capacity of the Indian economy shows the strength of basic fundamentals of the Indian economy and its capacity to bounce back,” he said adding sectors like tourism, urban development, infrastructure, and agri-based industry have a great potential to take forward the economy and for employment generation.

The PM’s meeting and his statement on Thursday were significant not only because they happen in the run-up to the Union Budget, which will be presented on February 1, but also because, once again, the Indian economy is being seen to be faltering.

The first advance estimates of national income for the current financial year, released earlier in the week, found that nominal GDP was expected to grow at just 7.5% in 2019-20. This is the lowest since 1978. Real GDP is calculated after deducting the rate of inflation from the nominal GDP growth rate. So, if for argument sake, the inflation for this financial year is 4%, then the real GDP growth would be just 3.5%.

Just for perspective, the Union Budget presented in July 2019 expected a real GDP growth of 8% to 8.5% and a nominal GDP growth of 12% to 12.5%, with a 4% inflation level.

What is the significance of the phrase ‘fundamentals of the economy are strong’?

The PM has reiterated a phrase of reassurance — underscoring the strong fundamentals of the Indian economy — that has been often used by policymakers in the past when the economy is seen to be faltering.

For instance, in October 2017, then Finance Minister Arun Jaitley brushed aside queries of the strains on economic growth by repeating this phrase. Earlier, during the sharp dip in GDP growth rate in 2013, both Prime Minister Manmohan Singh and Finance Minister P Chidambaram reiterated that the same phrase.

Globally, too, this phrase is a boilerplate.

One of the most infamous use of this phrase happened when on the morning of September 15, 2008 — the day Lehman Brothers (one of the most well-respected Wall Street brokerage firms) collapsed and unequivocally declared the Great Financial Crisis — then Republican Presidential candidate, Late John McCain reportedly stated that the fundamentals of the US economy are strong.

Roughly a year before that, in December 2007, then US President George W Bush told Reuters that “the country’s economic fundamentals were strong despite ‘headwinds’ from a weaker housing market, and he voiced confidence in a plan to ease the subprime mortgage crisis”.

So, what are the ‘fundamentals of an economy’?

When one talks about the fundamentals of an economy, one wants to look at economy-wide variables such as the overall GDP growth (real and or nominal), the overall unemployment rate, the level of fiscal deficit, the valuation of a country’s currency against the US dollar, the savings and investment rates in an economy, the rate of inflation, the current account balance, the trade balance etc.

There is intuitive wisdom in looking at these “fundamentals” of an economy when it goes through a tough phase. Such an analysis, when done honestly, can give a sense of how deep the strain in an economy run. It can answer the question whether the current crisis just an exaggerated response to a sectoral problem or is there something more “fundamentally” wrong with the economy that needs urgent attention and “structural” reform.

A spike in a 30-stock index, such as the BSE Sensex, could be misleading if it is out of tune with the GDP rate. Looking at a broader stock index, say a BSE500, may add to the picture. Similarly, comparing the growth of high-end cars to the slump in demand for cheap biscuit packets is also of limited analytical value. That’s because these high and lows may largely be due to some sector-specific factor, not an economy-wide factor.

To be sure about the broader health of the economy, one must look at the broader variables. That way, one reduces the chances of getting the diagnosis wrong.

So, what is the current state of the fundamentals of the Indian economy?

The data on most variables that one may call as fundamentals of the Indian economy are struggling.

Growth rate — both nominal and real — has decelerated sharply; now trending at multi-decade lows. Gross Value Added, which maps economic growth by looking at the incomes-generated is even lower; and its weakness in across most of the sectors that traditionally generated high levels of employment.

Inflation is up but the consolation is that the spike is largely due to transient factors. However, a US-Iran type of conflagration could result is a sharp hike in oil prices and, as such, domestic inflation may rise in the medium term.

Unemployment is also at the highest in several decades. According to some calculations, between 2012 and 2018, India witnessed a decline in the absolute number of employed people — the first instance in India’s history.

Fiscal deficit, which is proxy for the health of government finances, is on paper within reasonable bounds but over the years, the credibility of this number has come into question. Many, including the CAG, has opined that the actual fiscal deficit is much higher than what is officially accepted.

Bucking the trend, the current account deficit, is in a much better state but trade weakness continues as do the weakness of the rupee against the dollar; although on the rupee-dollar issue, a case can be made that the rupee is still overvalued and thus hurting India’s exports.

Similarly, while the benchmark stock indices have run up, and grabbed all attention, the broader stock indices like the BSE500 have struggled.