Okay, the Indian economy is in a slowdown and it is absolutely important for us to quickly get back onto the path of high growth. The $5 trillion-dollar question is “how”? Unfortunately, the public discourse over finding answers to this question has become mired in macroeconomic jargon, bureaucratic grammar and stock market clichés that are confusing even when they make sense.
Informed, educated citizens — like their political leaders — can be forgiven for being confounded when told that we have a twin balance sheet problem, banks stuck with NPAs and that transmission channels have to be strengthened and aggregate demand has to pick up. Sure, there is a need — and an important one — for technical discussion among macroeconomists, financial analysts, business journalists and policymakers, but it cannot be the only show in town.
What the disproportionate focus on macroeconomics misses is the fact that to increase economic growth, you need to change the behaviour of individuals and companies. It is important to realise that the economic slowdown is not a malfunction in an invisible, impersonal machine called the economy. Rather, it is the outcome of a change in our individual behaviour. People are not spending because they don’t have jobs, they have less money to spend or they are anxious about the future. Companies are cutting production because they sense declining sales, have inadequate working capital or are unable to secure loans. Exports are not growing fast enough. Investors are moving money into safe but unproductive assets like gold and real estate or moving it abroad. All the policy levers and technical twiddly-bits like interest rates, tax cuts, money supply and so on are ultimately instruments to effect behavioural changes.
Economic output is the sum of consumer expenditure, investment, government expenditure and net exports. The best way to increase growth is to increase all four of the above. That’s it. More than discussing interest rates and Sensex levels, we must now ask how do we get consumers to spend and invest more, firms to export more, and the government to walk the tightrope between spending enough while not borrowing, taxing or printing money too much.
So, what should we do?
In the immediate term, people most likely to spend money should be enabled to do so. Reducing personal income tax rates for salaried people and folding the highest GST rate to 18 per cent will galvanise spending and investment. It’s a good opportunity to implement the Direct Tax Code, that will lower income tax rates and expand the number of taxpayers. In rural areas, price regulation of agricultural commodities is a dampener — farmers are unable to take advantage of higher prices because governments impose price controls and export quotas.
A credible commitment to enabling massive employment growth — which requires deregulation and commitment to market competition — is likely to embolden consumers to spend more and make financial investments. Government policy must work towards persuading Indians — through both words and actions — that they need not be anxious about the future.
The current consensus, following economist and former Chief Economic Adviser, Arvind Subramanian’s arguments, is that firms are unable to borrow money from banks for working capital and business expansion, because of the legacy of bad debts. So, government policy is concentrated on fixing the “twin balance sheet problem”. While cleaning up bad debts, helping banks to recover and coaxing them to lend more is a good thing and perhaps necessary, we must be alive to the possibility that, as CMIE’s Mahesh Vyas argued, “the problem regarding the current investments slowdown was never in the balance sheet of the corporate sector or the banks. It was never a Twin Balance Sheet problem.” The upshot of Vyas’s argument is that if firms sense that domestic demand is back on the upswing, they have the ability to invest. Also, the undue focus on bank lending ignores other places where money can be “stuck” — big corporations and governments not paying suppliers on time, friction in the GST refund cycle and public procurement policies loaded against start-ups and small businesses.
Similarly, exporters can become more competitive in the short-term if domestic friction is reduced. Finance Minister Nirmala Sitharaman’s recent announcement of a new scheme to reimburse import taxes and increase credits is a step in the right direction, especially if it is unambiguous and simpler. This is only a salve — the real boost to exports can only come if India forcefully advocates free trade.
We have ended up with an entirely avoidable trade dispute with the United States and are beholden to strong ideological forces that are against entering international trading arrangements. Instead of exploiting the immense opportunities created by the US-China trade war, we are toying with the idea of repeating the failed trade policies of the Indira Gandhi era.
Let’s be clear: this back-to-the-1970s approach to international trade will take us back to the 1970s situation for exports. Finally, government expenditure is part of the solution in reversing the slowdown. Yes, lowering taxes and increasing expenditure at the same time will widen the fiscal deficit and take it well beyond the Fiscal Responsibility and Budget Management Act (FRBM) limits. Now big fiscal deficits are bad because government borrowing dries up the pool leaving little for private investors, and the debt repayment burden leaves less money for the things that a government ought to do. If the government orders the RBI to print money to finance its deficit, then we get higher inflation.
Yet in a slowdown, government expenditure can galvanise the economy if it is done right. At the same time, the government can afford to spend less on itself: all departments could implement a 5-10 per cent reduction in operational expenditure. Putting more money in the hands of citizens and public investment in infrastructure — highways, ports, capitals, defence equipment, education — will boost business activity and create conditions for a virtuous cycle of growth. Remember the 100 new smart cities? Getting even a handful of them started now can invigorate the construction sector and create millions of jobs in the medium-term. Why not create new “global economic zones” where foreign companies fleeing from China and elsewhere can relocate?
There are a couple of things that the Narendra Modi government must not do. The most important is not changing the rules in the middle of the game, or appearing to change rules to benefit or penalise individual companies. If investors — whether domestic or foreign — believe that the business environment in India is both unfair and uncertain, they will vote with their feet.
It is heartening to see that the slowdown has re-awakened us to need for structural reforms: in recent weeks, Vice-President Venkaiah Naidu, RBI governor Shaktikanta Das, CEO of Niti Aayog Amitabh Kant and high-profile Mumbai investor Rakesh Jhunjhunwala are among those who’ve advocated them. We’ve been waiting for them for 20 years. It’s a good time to roll them out.
The author is the director of the Takshashila Institution, an independent centre for research and education in public policy. Views are personal.