FY2019-20 will go down as ‘annus horribilis’ in India’s economic trajectory. The drop in growth was so swift and so large that it can only be described as a crisis. India is now officially growing at a rate below 5%. At this ‘Hindu rate of growth’, India will not even reach $5 trillion by 2030.
GoI is under immense pressure to boost demand by breaching the fiscal deficit. It is, in any case, going to be difficult to meet the fiscal deficit target, despite the huge windfall transfer of excess reserves of Rs 1.76 lakh crore from RBI. The revenue projections in the Budget are based on very unrealistic nominal GDP projections of 12% growth — 4% GDP deflator and 8% real GDP growth.
More important is to reorient government expenditures towards a more developmental growth-oriented outcome — lower the recurrent expenditures and increase capital expenditures. Lower borrowing costs and cuts in subsidies could provide some space for this improvement in the quality of expenditures.
Recovery in investment is key to recovery of the economy. Gross fixed capital formation as a share of GDP peaked in 2007-08 at 36% — it has since declined to about 28.5% — with private investment peaking at around 27.5% of GDP in 2007-08, and now slumping to 21.5%. Credit to the private sector as a share of GDP also peaked in 2013, and has since fallen — a contrast with Vietnam and Bangladesh, where credit growth has continued to rise despite a slowdown in global trade, as these economies have maintained export growth.
RBI has done its part to some extent. It has, over the last year, lowered the repo rate by 135 basis points to 5.15%. But only a third of this cut has translated into lower lending rates by commercial banks. Further cuts in RBI’s repo rate are unlikely, as consumer price index (CPI) inflation has now jumped to 4.6%, implying a real repo rate of 0.55%, lower than is warranted.
RBI’s Monetary Policy Committee (MPC) has reduced the repo rate by 135 basis points since last year. But it has had no effect on the weighted average lending rate (WALR). Over the last year, WALR has gone up by 1.9% points. In general, since the establishment of MPC in 2013-14, WALR has jumped from under 2% in real terms to around 7% for outstanding loans and 6% for new loans.
Bad Bank for the Good
Pressure to come clean on NPAs — no doubt badly needed — forced banks to increase their lending rates and hurt economic growth, via both the consumption and investment channels. The high real interest rates has also meant that the real exchange rate remains hugely appreciated — by around 15-20% over the last five years. Such a high real exchange rate has hurt India’s competitiveness. The cost of not setting up a bad bank and conducting bolder financial sector reforms has now come to bite the system.
Trade wars have added to the global slowdown. Nevertheless, the US-China ‘trade war’ was seen as an opportunity for several countries. So far, the biggest winner is Vietnam and, to some extent, Bangladesh. India seems to have missed the bus due to lack of competitiveness. Vietnam’s exports to the US have jumped by about 30%. It has seen huge inward investment from Hong Kong-based companies. India’s decision to not join RCEP may also make it a less attractive destination for firms leaving China.
India has moved up again on the World Bank’s ‘Ease of Doing Business’ rankings to 77th position. But it remains behind Vietnam, Indonesia, Thailand and Malaysia. India dropped 10 ranks to 68th on the broader World Economic Forum (WEF) Competitiveness Index, which incorporates the ‘Ease of Doing Business’ index, but includes other factors as well.
This suggests India will need to conduct more aggressive reforms in enforcement of contract, registering property, paying taxes and resolving insolvency, as well as conduct labour and financial sector reforms. The following will be needed to accompany the corporate tax cuts to boost investment:
*Set up a bad bank, and privatise some State banks. Insolvency and Bankruptcy Code (IBC) is a good reform, but too slow to deal with the systemic non-performing assets (NPA) problem.
*Labour flexibility for firms up to 500 workers.
*Liberalise agricultural markets and exports, and boost rural demand by shifting funds to PM-KISAN and MGNREGA by reducing electricity and fertiliser subsidy.
*Announce a new strategic trade and industrial policy, and select 8-10 industries for priority support, as was the case earlier for auto and pharma.
*A new tourism push, ‘Swagat India’, to match ‘Swachh Bharat’, to double arrivals in 10 years.
*Direct tax reform to complement corporate tax cut and widen the base.
*Aggressively consummate disinvestment, including Air India sale and Bharat Petroleum Corporation Ltd (BPCL), Shipping Corporation of India (SCI) and Cement Corporation of India.
A Stitch in Time
This will be finance minister Nirmala Sitharaman’s first real Budget — she had to ‘adopt’ the previous one and then take actions to repair its damage. It would be better to get out in front and announce a set of coherent, comprehensive, bold reforms.
It would also be wise to stick to a glide path of fiscal consolidation to leave more financial savings for the likely recovery in private investment, which can be further encouraged by bolder reforms to accompany the corporate tax cut.
The writer is distinguished visiting scholar, George Washington University, Washington DC, US