Reviving economic growth

The finance ministry, which is in the process of preparing the Union Budget for the next fiscal year would be well advised to consider some of the suggestions of the International Monetary Fund (IMF) made in its report on India. The IMF has listed reform measures that might help India increase economic growth to the baseline medium-term potential of 7.3 per cent. First, the clean-up of bank balance sheets should be completed along with strengthening governance in public sector banks (PSBs) and better oversight of non-banking financial companies (NBFCs). Although the government has infused a significant amount of capital into PSBs, there is practically no movement in terms of governance reforms. In the absence of such reforms, PSBs would remain prone to the same errors and undermine an efficient allocation of credit, which will affect overall economic growth in the medium term. Further, the central bank will need to augment regulatory capacity for better oversight of the system, including the NBFC sector.


Second, fiscal consolidation in the medium term should be anchored to the recommendations of the Fiscal Responsibility and Budget Management Act review committee. General government debt needs to be brought down to 60 per cent of gross domestic product (GDP) from about 69 per cent in 2018-19. Fiscal consolidation would require savings through rationalisation of subsidies and augmenting revenues by expanding the tax base. This will help reduce the crowding out caused by higher public sector borrowing requirement, which exceeds the net household financial savings of 6.6 per cent of GDP. However, the way the government manages its finances in the current and next fiscal year, to a large extent, will determine the possibility of attaining medium-term fiscal targets. In the current year, for instance, revenue collection is likely to fall short significantly.


Notably, the IMF has also highlighted the use of off-budget financing, which makes the headline deficit number less meaningful. There is an urgent need to improve transparency. Given the limited policy space, the IMF has suggested that fiscal stimulus should be avoided at this stage. Evidently, a significantly higher level of government borrowing will push up the cost of money. In fact, the Reserve Bank of India has started managing yields by buying longer-dated bonds and selling short-tenor bonds, which would also help the government borrow at lower rates. However, measures like these have limitations and could unnecessarily complicate policy management of the central bank. The government would need to be mindful of the risks associated with fiscal slippage at this stage.


Third, to boost growth, among other things, the government should focus on reforms in product, labour and land markets. Since the policy space on the fiscal side is virtually non-existent and there are limitations to the extent monetary policy can support growth in the given macro environment, the government should focus on wider reforms that will help increase growth in the medium term. For instance, comprehensively addressing the problems in the goods and services tax system will not only help augment revenue but also improve the ease of doing business. Further, there is a strong case for trade liberalisation to support growth and employment. The economy clearly needs policy intervention to help push up growth in a sustainable way.

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