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Economy: Modi's biggest test

Pravakar Sahoo, Oct 15 2017, 0:13 IST

Growth and jobs: The prime minister has so far failed on the most important promise he made to voters

Up until recently, the Indian economy was feted as the lone ‘bright spot’ among the major global economies. China’s growth was falling, India’s was on the rise, or so the story went.

Prime Minister Narendra Modi, Finance Minister Arun Jaitley and others in the government repeatedly said India was the fastest growing major economy. Even as several indicators in frequent data showed that there was something amiss, the GDP figure somehow seemed to stay high. Suddenly, though, in the first quarter of the current fiscal, the GDP figure slumped to a three-year low at 5.7%. And all hell broke loose, with a volley of criticism coming in, mostly from within the ruling BJP itself and its larger Parivar, against the government’s mishandling of the economy. What went wrong?

To be sure, the economy did not suddenly slump, as Modi’s critics have claimed, only due to demonetisation and the problematic implementation of the GST. Rather, the economy had been slowing down since the last quarter of 2015-16. Agriculture and industry, which absorb the maximum labour force, have decelerated since the third quarter of 2016-17. But the slowdown came to be widely noticed when the GDP growth rate hit a low in the first quarter of this fiscal.

The most important reason for the slowdown is the fall in investment in the economy, something that has been happening for a number of years now. Investment peaked at 38% of GDP in 2007, but since the global financial crisis, it has been continuously declining, falling to about 27% in recent months. The share of private investment within that has fallen from 32% of the total investment to 25% now. Most importantly, investment in manufacturing, agriculture and construction – sectors crucial for job creation -- have slowed down. No wonder we have been witnessing disappointing figures in job creation, down to just 91,000 in 2016.

Like investment, consumption, too, started to turn negative in the third quarter of 2016-17. With bad news all around, the RBI’s Consumer Confidence Survey index, too, has hit a three-year low.

What’s worse, with exports stagnant and now falling as the GST has hit the sector, the current account deficit surged significantly in Q1 2017-18 to 2.4% of GDP from 0.6% in Q4 2016-17. Overall, the state of the economy is a cause for concern and corrective steps need to be taken to revive it.

Although the problem of twin balance sheets in the corporate and banking sectors is at the root of the economic slowdown – banks are saddled with NPAs totaling some Rs 8 lakh crore and are unwilling to lend to the corporate sector; the corporates are reeling under high levels of debt that they cannot service nor find a resolution to and are therefore unable to borrow anymore to revive stalled projects – two big policy decisions of the government, demonetisation in November 2016 and the implementation of the Goods and Services Tax in July 2017, have aggravated it.

Demonetisation was a big blow to the supply chain and affected mostly the rural economy, informal sector and SMEs, whose business and trade depend on cash. No wonder, the Centre for Monitoring the Indian Economy (CMIE) reports that 1.5 million jobs were lost between January and April 2017 in the informal sector.

And just when it seemed that the impact of demonetisation was fading around July this year, the government rushed into the Goods and Services Tax without ensuring a smooth and efficient implementation. There are teething problems with GST and the compliance cost is high. It is not the tax rates per se, but high compliance costs in terms of filing returns, getting tax credits on time etc., affecting SMEs and export firms. The technical glitches in filing returns and delays in refund of input tax credit have hit businesses.

While both demonetisation and GST may have been well-intentioned, there are now serious concerns and the government needs to act quickly to address them.
So, what can government do? The immediate measures should include reviving private investment. The value of stalled projects

amount to about Rs 13.2 lakh crore, 6-7% of GDP, and many of them are stalled due to regulatory issues like land acquisition, environmental clearances, etc. It is expected that these will be low-hanging fruits for the government to resolve and get close of half of these projects going quickly. The government should also resolve the bad assets issue through the bankruptcy and insolvency code to help both the corporate sector and banks.

There is a demand slowdown, particularly in the rural and informal economy, and the government should focus its expenditure, even if it means missing the fiscal deficit target by a small margin, on rural housing, infrastructure, minor irrigation projects, etc., where the returns are higher and quicker. The government can mobilise resources for this purpose by going in aggressively for disinvestment.
Credit off-take has been plunging depths in recent quarters and therefore the government must recapitalise banks. That would help better access to credit in the economy and will reduce lending rates as banks are not fully passing on benefits of rate cuts by RBI.

There are a few quick measures on trade facilitation, such as streamlining processes, institutions, certification and inspections and logistics at ports that could help exports pick up. The world economy is growing and India cannot lose out on a chance to increase exports. However, Indian firms need to be a part of global value chains and regional production networks in ASEAN and East Asia to be able to export more. This integration depends on competitive production costs, quality and timely delivery.

There are serious worries on the jobs front. Demonetisation and GST have affected labour intensive sectors such as construction, gems and jewelry, textiles, leather and footwear, etc. It is time for the government to talk to sector-specific representative bodies to resolve their issues.

However, the latest numbers in September 2017 do show signs of recovery as manufacturing and exports have improved. Therefore, the impact of demonetisation and GST could perhaps be tapering. With some proactive measures by the government, the economy could bounce back soon. In any case, sustained high growth is possible only through continuing with reforms.

(The writer is professor, Institute of Economic Growth, Delhi)

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