Confronting macro challenges

As the freshly mandated National Democratic Alliance government prepares its first Budget, it confronts a daunting set of macroeconomic challenges, with every key macro indicator (except, importantly, inflation) flashing amber or red:

• Recently released official data show that GDP growth slowed markedly in the final quarter of 2018-19 to 5.8 per cent, the slowest in 20 quarters, thus bringing down the full year growth estimate to 6.8 per cent, the slowest in five years. This confirmed the sharp slowdown signaled earlier by many high frequency indicators such as the Index of Industrial Production, trade statistics, auto and consumer goods sales, purchasing managers’ indices, corporate earnings and so forth.

• Real investment growth in 2018-19Q4 tumbled to 3.6 per cent, manufacturing to 3.1 per cent and agriculture to minus 0.1 per cent. Private investment has been stagnant.

• On the same day, the government finally released the Periodic Labour Force Survey report by NSSO for 2017-18, which confirmed that the employment situation in the nation was the worst in several decades, with just under half the working age population actually working or seeking work (the labour force participation rate or LFPR). The LFPR for females was down at a dismal 23 per cent (one of the lowest in the world), and that for female youth at a pitiful 16 per cent. Among those in the labour force, unemployment was at a 45-year peak of 6.1 per cent, with very high rates among youth, ranging up to 27 per cent for urban females.

• The nation’s external financial balance is under stress, with the current account deficit in the balance of payments at an uncomfortably high 2.5 per cent of GDP. Worryingly, the single largest credit item, merchandise exports, has been stagnating since 2011-12, leading to a drop in its share of GDP to 12 per cent in 2018-19, compared to 17 per cent seven years ago.

• The country’s fiscal balance remains under pressure, with the combined deficit of the Centre and state governments at about 7 per cent of GDP, and the Public Sector Borrowing Requirement (PSBR) estimated at around 9 per cent of GDP. The latter yardstick has become more relevant given the growing propensity to manage fiscal deficit targets by transferring government expenditure (and associated borrowing needs) to public sector entities such as the Food Corporation of India. The government debt-to-GDP ratio is close to an uncomfortable 70 per cent of GDP and contingent liabilities are rising.

• The financial sector has been highly stressed for several years because of the  “twin balance sheet” problem of high levels of non-performing assets (NPAs) of commercial banks and the correspondingly high burden of unserviced debt obligations of companies (mainly) and households. There were some signs of having turned the corner over the past year, until the dramatic implosion of the hydra-headed Infrastructure Leasing and Financial Services (IL&FS) company last September, which has spread substantial contagion in the universe of non-bank finance companies (NBFCs) and beyond.

• Finally, the global economic environment of volatile energy prices and major trade wars is not conducive for an early economic recovery in India.

So what can be done to revive growth, investment and employment, improve macro balances and strengthen financial stability, both through the forthcoming Budget and outside it? Let us consider the usual macro level policy tools.
Illustration by Binay Sinha
Fiscal policy: Given the high levels of the combined fiscal deficit and PSBR, there is no room for additional fiscal stimulus. As it is, they are preempting all of the annual flows of household financial savings. Any further increase would simply crowd out private investment and shore up the already high levels of real interest rates on medium- and long-term loans. Given existing expenditure commitments, unprecedented recent revenue shortfalls and growing payment arrears, it will be a challenge to keep the Centre’s fiscal deficit at the already budgeted 3.4 per cent of GDP. Ideally, a modest reduction would be desirable. Strengthening the revenue yield of the Goods and Services Tax (GST) through procedural reforms and rate adjustments will be crucial, as will be the broadening of the base of direct taxes.

Monetary policy: Through three successive policy statements (the most recent last week) the RBI’s Monetary Policy Committee has reduced the policy repo rate by a cumulative 0.75 per cent, of which it estimates only about 0.2 per cent has been successfully transmitted to fresh bank loans thus far. This is hardly surprising, given the high levels of government borrowing (to fund fiscal deficits), which keep the long rates high. The overhang of high NPAs in public sector banks (mostly) and the elevated costs and risks associated with these, as well as the stresses in the NBFC sector, are also impeding transmission and reducing any positive impact on investment. Basically, fiscal dominance and financial sector stress are undermining monetary policy. These have to be resolved or reduced before expansionary monetary policy can become really effective.

Trade and exchange rate policy: The government needs to urgently reverse the past two years’ trend towards higher customs tariffs and overvaluation of the rupee and also engage more proactively with regional trading arrangements, notably the Regional Comprehensive Economic Partnership. Only then will the declining share of exports in GDP be reversed, India’s participation in global value chains enhanced, import substitution efficiently encouraged and growth impulses strengthened.

A reforms thrust: The best way to trigger higher private investment and growth is to launch a much-needed set of economic reforms. Even though the pay off will take time, clear and credible announcements of a package will revive “animal spirits” and spur investment in the short-run. The key reform areas include: Measures to overhaul labour laws and regulations to make them simpler and incentivise fresh employment in the organised sector; initiatives for easier land acquisitions for non-farm uses; a big push on agricultural marketing reforms and an overhaul of the very costly and distortionary public foodgrain procurement and distribution system; and strengthening the Insolvency and Bankruptcy Code process.

Ease of doing business: Much has been done; but much more needs to be done, especially with regard to exports and imports (trade facilitation).

None of this is new. But it’s all still necessary to revive growth, investment and employment. Business as usual risks the perpetuation of low growth, poor employment, financial fragility, and vulnerability to volatile oil prices and external capital flows.

The writer is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. 
Views are personal.

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