IMF cuts India's GDP: Demonetisation, GST aren’t the only villains; the pain has deeper roots

PMEAC will do well if it first acknowledges the problems on the ground and advises the government to act on land and labour reforms, disinvestments, bank recapitalisation and stalled projects

Dinesh Unnikrishnan October 11, 2017 12:44:40 IST
IMF cuts India's GDP: Demonetisation, GST aren’t the only villains; the pain has deeper roots

The newly formed Prime Minister’s Economic Advisory Council (PMEAC) is meeting on Wednesday amid a series of bad news on economy. Just on Tuesday, the International Monetary Fund (IMF) slashed India’s economic growth forecast by 50 bps. In fact, IMF cutting India 2017 growth forecast to 6.7 percent isn’t particularly surprising. It was only recently the RBI cut the growth forecast by an identical margin. Multilateral agencies typically repeat the projections of local authorities. Their actual insights into local economic conditions are often subject to debate. The reasons cited for growth slowdown were largely same in both cases — the ‘transient’ impact of disruptions caused by demonetisation and the goods and services tax (GST) rollout. Union Finance Minister Arun Jaitley immediately defended growth under the Narendra Modi government’s rule saying the economy continues to be on a stronger ground and the structural reforms undertaken will land the economy on a stronger growth path in another year or so.

The optimism is encouraging, but one factor the optimists tend to overlook is that the current slowdown phase in Indian economy isn’t really an outcome of the two principal reasons often cited — note ban and GST. The economy has been slowing for at least five quarters and the pain, in fact, has deeper roots. The demonetisation chaos and destocking of goods ahead of and price uncertainties following the GST rollout have only added to the pain. Remember, the Indian economy has been on a consistent growth path (above 7.5 percent) for at least eight consecutive quarters when it touched 9 percent growth in the fourth quarter of fiscal year 2016. From there, the downfall began. The GDP growth continued to decline touching a worrying 5.7 percent in the April-June quarter. If one looks at the gross value added (GVA) numbers, the fall in growth has been even sharper. It stood at 5.6 percent in the first quarter. Even this figure could be lower than what it shows on account of a higher base last year. Much of this growth has been supported by higher government spending rather than fresh investments by the private sector. GFCF (gross fixed capital formation) has been on a steady decline. Growth in manufacturing and industry has fallen while services sector growth helped to an extent in the June quarter.

IMF cuts Indias GDP Demonetisation GST arent the only villains the pain has deeper roots

Representational image. Reuters

More than mere numbers

Besides what the GDP internals tell us, other macroeconomic signals in the economy too have been worrying. Bank credit growth to industries has been on a contraction mode for a few years now. The contraction has continued so far this fiscal year with credit to large industries contracting by 1.7 percent while that to medium companies by 4.1 percent. It isn’t difficult to understand why bank lending is not happening despite banks receiving good inflow of deposits post note ban.

For one, there isn’t any major demand on the ground. New projects are hardly coming up. As this report by the Centre for Monitoring Indian Economy (CMIE) shows, the weak trend in new investments is continuing.

“Announcements of new industrial & infrastructural projects remained muted in the first quarter of 2017-18. Only 448 projects were announced during the quarter. This is the lowest quarterly project announcement seen since June 2014, the time when the last capex cycle bottomed out,” the CMIE report said.

Another reason why banks are hesitant to lend is the bad loan situation. The clean-up process is still halfway and no bank wants to add to the pile off stick assets. Also, banks are afraid to be in the scanner of investigative agencies lending to dubious promoters.

The pain areas do not end here. One big concern is not enough jobs are being created in the economy and imports are heavily relied upon to meet the domestic demand. This isn’t good for an ambitious economy which wants to become a global manufacturing hub, displacing the mighty China. In fact, a phase of prolonged growth slowdown is preceded by the rise in unemployment. This point is highlighted by Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management ,in his Times of India blog. “It is disappointing that India is missing out on the global revival in economic growth, but perhaps even more troubling that it is missing out on jobs growth – a trend that precedes the GDP slowdown but has also gotten worse over the past year,” Sharma said.

Way ahead

But, not all is bad in the economy. If corrective steps are taken without delay, it can be salvaged from a deeper economic slowdown. The argument that structural reforms can bear fruit in the long term is indeed valid. But, if the major concerns are not addressed quick enough, no amount of work can make a quick economic recovery happen. The PMEAC will do well if it first acknowledges the problems on the ground and advises the government to act on the following areas:

One, land and labour reforms need to be taken up with urgency initiating dialogue with the states. Difficulty in acquiring land and labour is one major reason why new private investors are not setting up factories here. This is of course, a politically sensitive issue and not an easy job. But with the BJP strong in numbers at the centre and gaining muscle in state assemblies, the task wouldn’t be too difficult for Modi government to handle. The problem in these areas is something IMF has highlighted yesterday. "In India, simplifying and easing labour market regulations and land acquisition procedures are long-standing requirements for improving the business climate," the report said.

Two, the government needs to be lot more aggressive on selling out the non-core assets and fast-tracking the disinvestment process to raise resources. The talk of a Rs 50,000 crore stimulus is on. But, there is no way the government can raise that kind of resources unless it works out some smart plans.

Three, at this point, the obsession with the fiscal deficit roadmap doesn’t make sense. If the deficit figure slips to 3.5-3.7 percent from the targeted 3.2 percent, there is no doubt it will not go down well with international rating agencies and economy watchers. But at a time when the economy is losing steam at a dangerous pace, supporting the growth momentum is the most critical.

Four, the Modi government needs to get ready for a commodity shock when international crude prices are set for a reversal from the low levels that immensely benefited it in the initial years. A sudden spike can upset the budget math.

Five, there needs to be a concrete plan on what to do with the nationalised banks. As of now, there is no clarity on this. Most of the 21 public sector banks are in dire need of massive recapitalication. Cleaning up the dirt on bank balance sheets is fine but who will fill up the massive holes this exercise will leave in bank balance sheets? The long-term solution, as this author has long argued, is to privatise these banks and let them compete in the market. The government cannot shoulder this burden for too long.

Six, there is a need to revive stalled projects where a significant amount of the bank money is stuck. The government has not yet found a solution how to revive these projects. As this report in the Mint shows, the number of stalled projects increased for the fifth straight quarter and accounted for more than 13 percent of total infrastructure projects under implementation. The report, citing the CMIE data, says the value of stalled infrastructure projects in the quarter ended September increased to Rs 13.22 lakh crore. That is the fifth straight quarter of increase.

Admit it, Indian economy is facing a structural problem that cannot be blamed just on demonetisation and GST. Of course, if the government didn’t go for the misadventure of the note ban, things would have been far better in the economy, especially among the small businesses. But, at a larger level, lot needs to be done to get the economy back on track. PMEAC should take note.

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