Despite all attempts including halved corporation taxes and low–negative if adjusted for inflation–interest rates to put the Indian economy on a double-digit growth trajectory, the actual numbers are often lower than expectations and forecasts. The latest GDP growth numbers are no exception. Against the RBI’s forecast of 16.2 per cent, India’s GDP could grow only 13.5 per cent in the April-June quarter.
India is far away from achieving the aspirational double-digit growth rates, notwithstanding the hype and chest thumping about being one of the fastest-growing large economies.
But what is hampering India’s growth prospects — cyclical or temporary glitches, or structural factors? And what does this mean for policy making, going forward.
The cyclical factors include a temporary ‘mis-match’ between supply and demand and tend to be short-term. For instance, the recent shortage of containers leading to surge in freight charges affecting exporters’ margins; Covid-induced demand-supply gap of PPE kits or hospital beds; or availability of more homes than buyers or more vacant tech positions than skilled workers leading to surging wage bills for IT companies such as Infosys and TCS.
Structural factors include long-term obstacles to a country’s economic growth prospects.
The extent to which a given challenge in the economy is cyclical or structural, has major implications for the effectiveness of monetary and fiscal policy deployed. Monetary and fiscal policy can be relied upon to deal with cyclical factors hampering growth. Thus, reduction in interest rates by the central bank (or tax exemptions on home loan interests) can help address insufficient demand for cars and homes. Such intervention can in turn prevent companies from laying off workers. But they will not be effective in dealing with structural challenges.
Currently, the Indian economy is faced with a combination of both, cyclical (temporary mismatch) and structural (long-term or permanent) challenges. Although it is the latter that has been hampering India’s growth prospects of late. To make matters worse, many of India’s cyclical problems are gradually turning into structural issues, often due to short-term focus and adoption of contradictory policy measures by successive governments and a self-serving bureaucracy.
How structural ills creep in…
Cane price populism (in India, sugarcane prices are fixed by the central and state governments) aimed at garnering the political support of an estimated 50 million cane growers, has turned the country into a structural surplus producer of sugar — India is producing more sugar than it can consume domestically. Thus, it must export or divert its excess sugar to ethanol. However, due to expensive raw material (cane), Indian sugar mills will need a generous dose of export subsidies if global sugar prices correct sharply. Similarly, if prices of crude oil crash, oil marketing companies will be faced with a dilemma of going slow on blending ethanol with petrol or help meeting ambitious blending targets and bear operational losses. To make matters worse, cane price populism is encouraging cultivation of this water guzzler crop in the water-scarce region of Maharashtra and Tamil Nadu, and creating ecological complications.
Similarly, India’s excessive raw material protectionism (with the help of high tariff walls and production subsidies) is inducing excess capacities in steel and other non-ferrous metals such as aluminum. Once the global commodity market cools down, India may have to deal with steel glut in case private investment sentiment doesn’t turn around or fiscally constrained government is forced to cut its infrastructure spending. Again, the policy focus on protecting capital-intensive large-scale manufacturing (of say, textile fibres) at the cost of labour-intensive but small scale manufacturing (of say, ready made garments) that would have absorbed thousands of unskilled and semi-skilled Indian workers, is not helpful.
Moreover, raising tariff walls increases the relative attractiveness of domestic markets vis-a-vis overseas markets, and thus runs counter to the policy of export promotion.
…coupled with monetary policy ills
Increasing capital intensity (encouraged by artificially low interest rates despite high inflation by the over-accommodative RBI, and neglect of smaller business entities that tend to be more labour-intensive vis-a-vis large corporations) in a labour-abundant country like India is aggravating the problem of unemployment. SMEs continue to be troubled by forced formalisation attempts, starting with the ill-advised demonetisation in 2016, followed by flawed design and implementation of the Goods and Services Tax (GST) that has created a compliance nightmare for smaller businesses and brought back the inspector raj. Thus, it’s no surprise that the country’s unemployment rate zoomed to 8.3 per cent in August as the number of employed Indians fell by two million to 394.6 million, according to CMIE. This is despite slowing population growth and India having one of the world’s lowest labour force participation ratio (the proportion of a country’s population either working or looking for jobs) at 40 per cent or so compared to China (68 per cent), Indonesia (68 per cent) Republic of Korea (82 per cent) and Vietnam (74 per cent).
Low labour force participation and high unemployment rates (especially among youths) impose a cap on India’s potential growth rate. Increased productivity can make up for lower workforce participation, but only up to an extent. Beyond that, the GDP growth will eventually start slowing. Besides, fewer people working also means lower purchasing power and a smaller sized market that will make it difficult for businesses to reap the benefits of economies of scale.
Moreover, low interest rates tend to encourage over-borrowing and sub-optimal use of scarce capital. The result is an increase in the incremental capital output ratio – which means India will need increasingly more capital to maintain the same level of GDP growth. That will aid the growth in bad debts.
Similarly, the slashing of corporate taxes—which essentially excludes SMEs, sole proprietorship, and partnership firms as well as LLPs—will aid the concentration of economic power with a few large corporations and increase inequality of income and wealth that will cap consumer demand and in turn the GDP growth from the demand side.
Again, the differential taxation of financial and non-financial income is fuelling the ‘financialization’ of the economy, leaving behind the real economy. Why invest in a factory and take the trouble of dealing with archaic rules and regulations related to labour, and inspector raj, in addition to taking on all kinds of business risks – regulatory as well as non-regulatory that lower the potential return on investment, say in manufacturing. Why not invest in a booming stock market/mutual funds (tax rates 10-15 per cent) that could easily give returns of 12-15 per cent. The Nifty index, one of the two benchmark indices, gave an average return of 12 per cent per annum in the last 20 years. So why take chances? The side effect could be loss of thousands, if not millions of manufacturing jobs in the process.
Again, India is trying to achieve an increase in investment rate that in turn will require an increase in its savings-to-GDP ratio. But the gross domestic savings-to-GDP ratio fell from 33.9 per cent in 2012-13 to 28.2 per cent in 2020-21. Beside, runway inflation and stressed household finances, one of the reasons for the decline in savings could be the increasing migration of the rich and high net worth individuals (HNIs) who tend to have higher marginal propensities to save (MPS) than the poor. Lower savings will adversely impact investment and in turn India’s GDP growth. A combination of higher effective taxation and poor civic amenities could be an important factor driving the rich and wealthy out of India to low tax destinations.
Unless India addresses these structural issues, its economic growth will remain sub-optimal. Blaming temporary glitches such as pandemic or global slowdown for the country’s poor GDP growth won’t help.
Ritesh Singh @RiteshEconomist is a business economist and currently the CEO, Indonomics Consulting, a policy research and advisory startup. Steven Raj Padakandla @pstevenraj1 is a faculty at IMT, Hyderabad. Views are personal.
(Edited by Anurag Chaubey)