Some thoughts on the Indian Economy

There is a growing chorus of voices calling for policies to stimulate aggregate demand, revive animal spirits, and restore the corporate investment cycle. The time-frame for action has to be immediate with impacts felt immediately on implementation of the policy or intervention. 

This demand has little theoretical or even practical basis and creates the danger of pursuing the path of attractive but harmful short-term measures.

The standard economic toolkits for stimulating aggregate demand involves the policy instrument and its target audience. 

In terms of policy instruments, the orthodox choices are fiscal and monetary policies. In the present circumstances, the former is constrained by the limited fiscal headroom available for the government. The latter is constrained by its poor transmission arising from the bad health of the banking system and the weak investment climate. In the circumstances, the cupboard of orthodox toolkits available is bare.

There is a third choice, involving specific sectoral or targeted policies. The problem with this approach is that they run the risk of targeting the wrong sectors with the wrong kind of initiatives and in the process creating distortions. The previous government’s post-crisis response in terms of revenue expenditures is a good example of the dangers. Besides, even in the best of cases, these measures take effect with a lag and are therefore less likely to have much immediate impact. 

In terms of audience, there are clearly four distinct audiences. They are households, urban and rural, corporate sector, and government agencies. 

1. Government agencies – Front-loading of the investment cycle of the public sector units, where they already have the resources available and their respective Boards and managements have approved investment proposals. In such cases, expediting these investments can be a very big booster.

2. Corporate sector – Facilitating and expediting the planned investments of private corporates, especially in sectors like infrastructure. This will require facilitating with government approvals and regulatory clearances. It may also be useful to think of some fiscal incentives on some of these expedited investments.

3. Farmers - One measure would be to lift the just-imposed export restrictions that have been imposed on the likes of onions and allow farmers to benefit from higher global prices. While such restrictions may perhaps benefit the consumers, it ends up penalising farmers who are anyways forced to bear the brunt of the downside of such market cycles without being allowed to benefit from the upside.

4. Households - The equivalent of corporate tax cuts on the income tax side has its strong political appeal. But it runs the risk of seriously destabilising the fiscal balance. So, it should be avoided.

5. Specific actions aimed at sectors 

• The two sectors are large enough to stimulate broad-based consumption are agriculture and construction. Construction in particular has a high multiplier.
• Agriculture – The demand stimulus of 2008-11 came primarily from measures like raising minimum support prices etc. Its adverse consequences in terms of inflation and fiscal deficits are well known. Any step in that direction may be misguided.
• Real estate – Given the large stock of stalled housing projects, some appropriate measures to expedite completion of the large pool of delayed construction projects; simplification of the processes to facilitate increased utilisation of the CLSS scheme for affordable housing etc.
• Urban sector – If the government does resort to some form of fiscal measures to stimulate using public spending, then transferring funds to cities is perhaps more appropriate. Among all government agencies, urban local bodies are perhaps more capable in terms of spending the money received in reasonable time. 
• General corporate sector – Now that corporate bottom-lines have been boosted by the corporate tax cuts, it may be perhaps useful to explore which sectors or categories of companies are likely to benefit the most. It may be useful to engage with those corporates to facilitate their investment decisions by easing various kinds of government-related restrictions in the hope of quickly ploughing back some share of the money channelled into corporate balance sheets by the tax cuts. 

As can be seen, the list of immediate aggregate-demand boosting measures is very limited. Further, the underlying premise that such boost to the aggregate demand can trigger animal spirits, which in turn can revive the investment cycle is very doubtful. For a start, the weakness of the Indian economy today is not a sudden turn of events, but part of a trend over several recent years. 

The current despondency with the Indian economy gets amplified when one compares it with the high growth rates of 2003-04 to 20010-11. But that lens may be misleading for multiple reasons. 

For a start, there are compelling reasons to believe that that episode of high growth was not built on the foundations of any significant and sustainable productivity growth. Instead, that growth episode was sustained by very high credit growth and an unsustainable boom in investments, especially in real estate and infrastructure sectors. It also coincided with a period of frothy asset prices, with attendant income effects. Adding to this was the largely rural-focused burst of welfare spending of the government by way of the likes of employment guarantee scheme, increases in MSP etc. The cumulative impact on aggregate demand was accordingly exaggerated.

Then there were the external tailwinds associated with rapidly expanding global trade, the China-effect, and high global economic growth rates. This growth was not sustainable. We lost a great opportunity to undertake critical plumbing reforms – improving the ease of doing business; fixing education and health care systems; enhancing state capacity; urban sector reforms like promoting vertical development, transit oriented development, and affordable housing; investments in rural infrastructure (including agriculture); improving governance of public sector banks; second-generation reforms to infrastructure contracting; policies on resource allocations; agriculture sector related policies and so on. 

Also missed was the opportunity to pursue proactive industrial policy to support a few sunrise and higher value sectors (renewables, electronic components including telecom equipment, software products) like that with the belated phased manufacturing policy (PMP) adopted for mobile phones since 2017. In fact, policies like GST and increased regulatory oversight on the banks (SMA accounts, PCA framework etc) should have been done during those boom times. 

Today, the aggregate demand boost provided by all these exogenous factors has died down. Further, the Indian economy has also been hobbled by the balance sheet problems of the banks and the corporate sector. Exacerbating the problems, the fiscal space available with the government is negligible. The global tailwinds have reversed to become headwinds. The world economy has definitely moved into a lower growth trajectory since 2010, and there may have been a further blip since 2017. World trade growth has plateaued, and even contracting.

There is enough to suggest that the current weakness is part of a trend decline in the potential output, starting sometime since 2011. There are several signatures of this. None more important that the gross domestic savings and gross fixed capital formation, both of which have declined significantly since 2011-12. The growth in exports, imports, credit, electricity consumption, IIP and so on have all moved to a lower trajectory.

In the absence of rigorous analysis, it is difficult to pin the source for these troubles. This period coincided with the surfacing of the banking sector non-performing assets, rise in stalled projects, renegotiation requests with the large numbers of contracts allocated in the 2003-09 period, the spate of scandals, the court cancellations of resource allocations, and of course the tapering off of the post-crisis stimulus measures. Not to speak of external factors. What role did these all play?

In the circumstances, even as the various immediate growth revival measures are being tried out, we should not lose sight of the long-term structural reforms that are essential to restore sustainable growth. We should both repair (like with bank and corporate balance sheets) and reform. In fact, the mere perception that those repairs and reforms are being initiated and also being implemented with right earnestness can perhaps go some way in signalling to the markets, shaping expectations, and thereby reviving the animal spirits.