Bold steps needed to push economy

The Indian economy is facing a slowdown in economic growth at 5.8 per cent in Q4 of 2018-19 and 6.8 per cent for the year as a whole as measured in terms of GDP, the benchmark measure of economic growth in India and globally. This quarterly growth rate number, it may be noted, is being witnessed after a long period of about 18 quarters. Besides, during 2018-19, the quarterly growth rate has been consistently decelerating: from 8 per cent in Q1 to 7 per cent in Q2 and 6.6 per cent in Q3.  It may also be noted that the slowdown in the economy is also accompanied by a high unemployment rate across the labor force – skilled, semi-skilled and unskilled. Together, they paint a gloomy picture of the economy and pose a tough challenge to the new government. There are reports of big bang reforms on the way but navigating these times is not going to be easy.

The numbers paint a gloomy picture of the economy and pose a tough challenge to the new government. There are reports of big bang reforms on the way but navigating these times is not going to be easy.

First, it is important to understand the nature of the slowdown that has taken root. The major contributing factors for the slowdown from the demand side are a deceleration in investment rate measured in terms of the percentage share of Gross Fixed Capital Formation (GFCF) to GDP in Q4 to 30.7 per cent from 32.8 per cent in Q1. When analysed from the supply or economic activity side, technically called Gross Value Added (GVA), the economic growth slowdown was primarily attributed to collapse of agriculture growth in Q4 to a negative growth of 0.1 per cent from 5.1 per cent in Q1. Besides, there has been consistent deceleration in agriculture and allied sectors in all the quarters (Q2: 4.9 per cent, Q3: 2.8 per cent) which has resulted in a lower y-o-y increase of 2.9 per cent than that of 5 per cent in 2017-18.

We must ask if the slowdown is statistical (i.e. because of the base effect) or cyclical or structural or a combination of these? It may be mentioned that in any statistical measurement, the base effect cannot be ignored, implying that a higher growth recorded in the previous year may result in a lower growth in the following year. But consistent lower growth on quarterly basis cannot be ignored as temporary and cyclical. Moving the economic growth to a higher trajectory from lower level of sub-par 7 per cent (6.8 per cent) in 2018-19 and 7.2 percent in 2016-17 is a challenge for the new government.

A growth rate of 7.4 per cent and further moving the economy to its potential level of 7.5 – 8 per cent is a bigger challenge for the NDA government now...The conventional demand management of lowering interest rate through policy repo rate reduction in the arena of monetary policy is only a second-best solution at the current juncture.

he RBI forecast of April 2019 as reported in RBI’s Monetary Policy Report (MPR), the Indian economy would witness a growth rate of 7.2 per cent in 2019-20 and 7.4 per cent in 2020-21. This baseline scenario assumes a normal monsoon, benign CPI inflation and no oil shock. But the situation has reversed. As against 7 per cent growth projected by the RBI, the growth rate was 6.8 per cent in 2018-19. The assumption of normal and timely monsoon looks belied as the IMD has already made a forecast of delayed monsoon. Evidence suggest a delayed monsoon results in a below normal monsoon. In the event of such a situation, there is adverse pressure on agriculture in general and prices of vegetables and fruits in particular. This development will result a ‘U’ turn in the benign food inflation situation and thus will result in a upswing on the inflation front. If there is a reversal in inflation, growth will be adversely affected. Besides, the geo political tension in trade relations with the USA on the export front coupled with the possibility of oil price hike will swell the current account deficit (CAD) from the present level of an estimate of 2.3 per cent GDP. This will put pressure on the exchange rate and will pose a potential threat to the management of capital flows and financing of the CAD in a non-disruptive manner.

We need bold structural reforms, engaging with supply side management. The conventional demand management of lowering interest rate through policy repo rate reduction in the arena of monetary policy is only a second-best solution at the current juncture.

rom the foregoing, it is pertinent to note that recording a growth rate of 7.4 per cent and further moving the economy to its potential level of 7.5 – 8 per cent is a bigger challenge for the NDA government now in its second term. The government therefore needs to take bold structural reforms, engaging itself with supply side management. The conventional demand management of lowering interest rate through policy repo rate reduction in the arena of monetary policy is only a second-best solution at the current juncture.

One way to address the supply side management is to look at the ratio of investment and Incremental Capital Output Ratio (ICOR). The investment rate needs to be supplemented by greenfield Foreign Direct Investment (FDI). In this context, it is important to revisit and relook at the sectoral caps. So far as the domestic savings rate is concerned, there is an urgent need to reverse the dis-savings of the government by eliminating revenue deficit which was 2.3 percent in the actual figure of 2018-19. This requires appropriate structural tax reforms by widening the tax base and increasing voluntary tax compliance – a long term game.

PSU sales have become inter-governmental adjustments as PSU banks and institutions end up buying shares when the market does not. Thus privatization cannot be forced or rushed – it must await its time, and can only be a slow process, as evidence has shown over the past several years.

Further, the government needs to urgently look at crating or enabling new employment opportunities in general. This ties into investments in physical and social infrastructure and increasing efficiency through higher productivity. ICOR on an average has been four (indicating four units of capital required to achieve one unit of economic growth) while the global benchmark is reported in the range of two, and any reduction in ICOR critically hinges on increasing productivity.

A lot of this is hard work done by series of actions that fix structural issues and can drive change in the medium and longer term. There is in the end no quick fix to the given situation. Suggestions that the government will go on a PSU-privatisaton spree, as reported, carry little meaning because in the end who will buy the PSU shares when the economy is weak and businesses are not reporting good numbers. This is precisely what has happened in the past – PSU sales have become inter-governmental adjustments as PSU banks and institutions end up buying shares when the market does not. Thus privatization cannot be forced or rushed – it must await its time, and can only be a slow process, as evidence has shown over the past several years.

If there is a reversal in inflation, growth will be adversely affected. Besides, the geo political tension in trade relations with the USA on the export front coupled with the possibility of oil price hike will swell the current account deficit (CAD) from the present level of an estimate of 2.3 per cent GDP.

In general, supply managements in terms of enhancement of productivity holds the key to higher growth and employment. Bold policy decisions on land reforms, labor market reforms, tax reforms for voluntary compliance, skill development through vocational training and strengthening of physical and social infrastructure and autonomy to the functioning of key institutions should be the focus of the new government. Some of these are on the way but with the weather gods not smiling (at least for now), many a plan could go haywire.