Slowdown is cyclical and structural; remedies difficult

The economic slowdown is official now. Hence, economists of all hues are trying to analyse the causes of and the remedies for it.

The first debate centers around the question: Is it cyclical or structural? It is not mere hair-splitting as the remedies would differ depending on the nature of the slowdown. By ‘cyclical’, economists mean ups and downs in economic activities over a business cycle which lasts over several years and would typically correct itself, with some countercyclical actions (drawing on lessons from standard macroeconomics) from the monetary, fiscal and exchange rate authorities. But ‘structural’ slowdown requires a different kind of policy response, aimed at changing the structural features of an economy (such as in the markets for land, labour, capital, agricultural products).

The broad consensus is that the current slowdown is due to a mixture of cyclical and structural elements. It is cyclical to the extent this is due to excess production and inventories geared to a higher level of projected growth in demand than actually realized (especially in sectors like real estate, automobiles, mining and construction materials), which periodically happens in many countries. Typically, such cycles end after a period of protracted slowdown that eventually brings production and inventories back to normal levels.

But, in the present context, this is compounded by structural issues like rising NPAs of banks and the collapse of IL&FS and NBFCs causing widespread credit squeeze, rising real interest rates (due to falling inflation), uncertainties and compliance costs for MSMEs due to GST, ongoing farmers’ distress (due to inadequate public and private investment in irrigation and rural infrastructure, falling water table, making cultivation of traditional water-intensive crops like rice and sugarcane riskier, inefficient agricultural marketing system resulting in farmers getting a disproportionately low share of the final price, inadequate insurance against variable weather and farm prices, except for a few grains under MSP, absence of alternative employment opportunities for underemployed agricultural workers), inability of the government to go for compensatory public expenditure, thanks to the emerging fiscal crisis (arising out of shortfall in tax revenue and PSU disinvestment proceeds, together with the compulsion to stick to the fiscal deficit targets to satisfy international credit rating agencies and FIIs).

Finally, specific auto sector (comprising 2-wheelers, 3-wheelers, passenger cars, heavy commercial vehicles) developments such as the announcement of a switch from BS-4 to BS-6 emission standards, which is making people postpone buying new vehicles, as they wait for BS-6 vehicles, the government’s push for electric cars to replace conventional cars, the requirement to buy car insurance for three years (five years for 2-wheelers) at the time of purchase, instead of for one year, the increasing preference of people for shared cars and the services of cab aggregators like Ola and Uber instead of owning cars are all contributing to the falling demand and the resulting buildup of huge inventories of cars, stoppage of production and layoff of workers across the entire supply chain, with disastrous negative ‘multiplier effects’ throughout the economy.

The remedies follow from the analysis. Evidently, it is easier to do some things in the short run than others. For example, some extension of the time frame for switching to higher emission standards and EVs, doing away with the requirement to buy 3-5 years of insurance at one go can be accomplished very quickly. A relaxation of the fiscal deficit targets in the interest of a temporary ‘fiscal stimulus’ may not be difficult to achieve either. The credit rating agencies and foreign portfolio investors (especially in equities) should be as much concerned (if not more) with the growth rate of the economy (which largely determines the profitability of investments in India) as with the projected fiscal deficit target. If more government investment leads to the easing of infrastructural bottlenecks, a temporary (not run-away) breaching of the fiscal deficit target may encourage more (domestic and foreign) private investment, instead of ‘crowding out’ such investment.

Reforms in land, labour and agricultural markets, though being talked about for a long time and tried in piecemeal fashion in a few states in the hope that their success in inviting investments and creating jobs may encourage other states to initiate similar reforms, are far harder to achieve. These (like allowing contract farming, 100% foreign retailers, leasing of fragmented lands to big companies, liberal use of contract workers but with better compensation packages than now, greater flexibility in firing workers along with more attractive severance packages), better compensation and rehabilitation packages for displaced people, especially in tribal forested areas, are all fraught with strong political opposition (not only from labour but also from various industry lobbies) and involve a tradeoff between efficiency and equity.

Nonetheless, the absence of these reforms has not made the economic situation suddenly any worse and hence cannot be held responsible for the current slowdown. Consequently, there is no additional harm if such reforms have to go through the tortuous process of consensus building in a chaotic multi-party democracy like ours (unlike China or Vietnam) where political parties, when out of power, invariably oppose the same policies that they initiated while in government.

We should also remember that wrong timing may discredit even a good policy. At this time of economic slowdown, the government should have postponed the merger of public sector banks, even if it may be needed for the longer-term health of the banking system. It will divert the attention and energy of bank officials from the urgent task of tackling NPAs and providing credit (the need of the hour) to coping with various disruptive adjustments and compliance issues connected with the merger process.

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