Govt’s left with only one option

Reviving Economic Growth

What is the state of the Indian economy at the beginning of 2020? With growth progressively sliding down to 5%, the slowdown seems to be firmly entrenched. It is interesting to compare the views of the recognized experts on this question.

The so-called ‘liberal’ economists such as Kaushik Basu (chief economist during the UPA regime), Manmohan Singh (economist and former PM), to the extent that their views can be discerned from their statements/interviews as reported in the media, hold some factors particularly responsible for the slowdown. These factors include bad policies (like demonetisation, or DeMo, implementation issues of GST); flip-flop in policies (corporate tax, foreign exchange laws) and the consequent lack of trust among domestic and foreign investors in the stability of policies and their interpretations; the arbitrary role of enforcement agencies in investigating/prosecuting ministers and officials presumably working in good faith, though with undesirable consequences, which has led to policy paralysis (remember this was considered the problem in the last years of UPA-2 also); excessive concentration of decision-making power in the PMO, leading to delay and arbitrariness in policymaking.

Also, these experts do not particularly emphasize structural reforms in land, labour or capital markets as the urgent need of the hour. If anything, their stress is on administrative reforms. Even if some of their points are valid to some extent, it is difficult to say that the situation on these counts has suddenly become so bad that it would bring about the prolonged slowdown we are seeing.

So, the more significant proximate causes may lie elsewhere. Here, the views of Arvind Subramanian (the previous chief economic adviser to the Modi government) and Raghuram Rajan (RBI governor in parts of both UPA and Modi regimes) should deserve special attention. Firstly, Subramanian was an insider involved in policymaking till very recently and cannot be labelled a ‘liberal’ with anti-Modi bias by any stretch of imagination. He was also one of the first experts to question the rosy official growth figures. Whatever Rajan says, especially on the current state of financial institutions and monetary policy, partly reflects the after-effects of his active policy years (except for the DeMo decision).

Their separate analyses puts the primary blame on the critical state of banks and non-bank financial institutions (NBFCs) due to prolonged bad lending and the consequent accumulation of excessively high NPAs, especially in financing infrastructure (power, roads, steel) and real estate and housing sectors.

In this context, apart from reckless lending without sufficient due diligence, particularly in the exuberant years of growth under UPA, which led to subsequent excess capacity in many sectors, Subramanian holds that the manner in which the DeMo exercise was conducted a further contributory factor. The return of so much of cash to the banks following DeMo made the banks flush with funds while DeMo discouraged fresh investment, particularly with the real estate sector undergoing special scrutiny as a generator and user of ‘black money.’

As a result, the banks lent the funds to NBFCs (subject to less supervision and regulation) which, in turn, led to bad and corrupt lending (Maharashtra Coop Bank is a glaring example) which spread the financial sector infection to the larger universe of NBFCs.

The lending to MSMEs, a major source of employment generation, suffered as NBFCs collapsed. This came on top of the suffering of MSMEs as a direct result of DeMo and the additional compliance costs and hassles following the introduction of GST.

The current government’s Mudra Scheme, which is channelling huge amounts of bank funds to questionable self-employment and small enterprise start-up projects as a result of government pressure, is another potential source of bad health for the financial sector in the coming years. The receivers of these funds are often under the impression that they would not have to repay the loans (as sooner or later, one or the other government will offer ‘debt forgiveness,’ which has become a standard vote catching practice of all political parties).

Abhijit Banerjee, the newest Indian Nobel laureate, seems to hold yet another view on the ongoing slowdown. He regards it as a further instance of the so-called ‘middle income trap,’ just like China (and many other countries in the past) is encountering. According to this view, the high growth performance lasting for more than a couple of decades following economic liberalization was primarily due to better allocation of resources and the consequent efficiency gains. That phase is largely over in both China and India, leading to lower growth rates as the ‘new normal.’ If so, the government’s efforts should focus on improving the quality of life of the people, rather than on enhancing the economic growth rate.

Irrespective of the differences among economists, almost everyone agrees that the immediate problem is the deficiency of aggregate demand. In the midst of pervasive excess capacity, stimulation of private investment cannot be achieved by corporate tax cuts, even if it is only for new plants. The businesspeople and their tax advisers will find ways to label relocation of existing plants as new investment to reap tax benefits. It will simply worsen tax receipts without any corresponding growth dividend.

Cutting personal income tax rates or GST rates is not feasible given the worsening fiscal deficit situation. Hence, more public expenditure on infrastructure building is the only option left, even if it leads to a temporary rise in the fiscal deficit. The international credit rating agencies are likely to condone this, to the extent that this pulls up the sagging GDP growth rate. Both domestic and foreign investors would be more concerned with the future growth prospects of the economy rather than the fiscal deficit target, the interest rates or the tax rates.

(The writer is a former professor of Economics, IIM-Calcutta)