Reviving the flagging economy
The government seems to have recognised that there is a slowdown; but it has misdiagnosed the problem, and cannot provide the right medicine for the economy.
It’s raining announcements at the Finance Ministry: almost every day now brings some major announcements about plans and measures designed to revive the flagging economy. If nothing else, the idea seems to be to indicate that the central government is no longer in denial about the economic slowdown and is coming out all guns blazing to address the problem. It is definitely a relief that the government’s head has finally come out of the sand, and instead of continuing to claim that “all is well”, it has recognised the current crisis. But are the numerous measures announced recently enough or in the right direction? More importantly, do they even indicate that the government has grasped the exact nature of the problem in the Indian economy?
All the important economic indicators have been down or falling for several months now, and in some cases even longer. GDP growth for the last quarter is down to 4.9 per cent – the lowest in 25 quarters, even on the basis of what are widely seen to be suspect GDP estimates. Investment rates have been declining for several years, while labour force survey data suggest that aggregate employment fell substantially, in excess of 15 million workers, between 2011-12 and 2017-18. Exports have been stagnant or falling. Domestic sales have been falling in automobiles and consumer durables, and more recently even in some non-durable consumption goods. Real estate and construction are in a state of deep gloom.
All these indicators point to one overwhelming reality: there is a genuine slump in aggregate demand in the country, driven by slow and now declining consumption. This in turn is a result of a combination of past sins of commission (the disastrous demonetisation and the poorly implemented GST) that have had a medium-term impact on destroying informal economic activity. This has festered for several years, and eventually became so extreme that it also affected formal enterprises, as we are now seeing. The continued neglect of agriculture despite so many mass protests by farmers meant that their incomes have not improved either. Employment declines and real wage stagnation further lowered consumption demand. In such a context, both capacity utilisation and profit expectations are bound to suffer, affecting investment plans adversely.
Meanwhile, the overhang of bad debt with commercial banks and then the mess in non-bank finance exemplified by the collapse of the finance company IL&FS meant that banks were unable or reluctant to lend and finance became scarce especially for medium and small enterprises. So, even those who are willing to borrow are unable to access the required funds.
All this was associated with a complete mess being made of public finances, after the poorly implemented Goods and Services Tax managed to create big problems for enterprises but still delivered tax revenues well below projections. This led to a gaping hole in central government tax receipts: tax revenues retained by the Centre were actually lower than the “Revised Estimates” by a whopping Rs 165,176 crore, or as much as 13.5 per cent of the revised estimates of total tax revenues. The fudge has still not been adequately explained by the Finance Ministry, nor have the final actual budgetary numbers been publicly released, but what is clear is that the public finances of the country reflect the broader economic mismanagement. In this context, the RBI’s decision to provide Rs 1.76 lakh crores of its surplus reserves could simply help the government to save face and meet its budgetary targets, rather than enabling any real new fiscal stimulus.
But for the past week, a flurry of measures has been announced that are supposed to rectify the situation. Rs 70,000 crore is to be infused into public sector banks to help them clean up their balance sheets by writing off some of the Non-Performing Loans. But this amount had already been announced in the July 2019 Budget, so the only new idea is to provide this amount all together now. However, it has been widely noted that this amount is inadequate to cope with the extent of bad loans – and more importantly, just cleaning up banks’ balance sheets will not instigate growth in the economy if there are no investors willing to take the loans in a sagging market. On the banking front, the latest is the announcement of merging ten Public Sector Banks (PSBs) to create only four entities, leaving a total of only twelve PSBs in the country. Whatever be the motivation and other implications of this policy move, it is surely likely to create some disruption in these banks that would at least for a time impair their ability to concentrate on expanding their loan portfolios. So the timing of this particular announcement is odd to say the least, unless the only intention was for the optical value, to create an impression of activity by the Finance Ministry.
Another announcement was the reversal of the move announced in the July Budget for additional taxation of foreign portfolio investors and high net worth individuals, who had been imposed an additional cess on their taxes. But this will do nothing to increase domestic demand; the only benefit would be for the stock market, which has indeed seen some minor recovery since the announcement of that rollback.
The automobile sector has been seen as a bellwether of the economy, so the government is particularly sensitive to its performance. Declines in output and employment in this sector have created extreme concern. But this government has declared its goal of moving the country entirely to electric vehicles within a few years, so any policies to revive this industry should have factored that in and been designed accordingly. Instead, it has announced an end to the freeze on public sector purchase of new combustion engine cars! This is completely inexplicable except as a panic knee-jerk response.
The main problem with all of these measures is that the government does not seem to have recognised the basis of the current slowdown: the shrinkage of aggregate demand, and especially mass consumption demand. If it had recognised this, it would implement immediate measures to revive such demand, for example by expanding spending on the rural employment guarantee programme and increasing social spending in urban and rural areas, both of which lead to direct increases in consumption and have significant multiplier effects. It would also think of ways to increase public investment in “green” areas that will be essential for future growth.
The Indian economy is ailing; what is making it worse is that the official doctor was first in denial and now has misdiagnosed the problem, and so is not giving the correct medicine.