A fact which is generally accepted today is that economic growth in the country has slowed down even though there is debate on whether or not demonetisation or GST are responsible for the same. GDP growth of 5.7 percent in the first quarter and IIP growth of 1.2 percent in July combined with a higher current account deficit of 2.4 percent of GDP for the first quarter do reflect some weakness in the economy. The fact that bank credit growth is negative so far this year is a concern. Investment continues to decline and hence there is limited scope for acceleration in growth as the multiplier will remain weak. The question being asked is what can be done to boost growth?
First it should be understood that growth is a continuous process and one can never expect GDP growth to jump up from 7.1 percent last year to 8 percent plus number this year. If this is accepted then the expectations would be softened to an extent. Growth always tends to move typically in a U shape meaning thereby gradually.
Sudden spikes which are V shaped are the exception rather than the rule. If this is also agreed upon, then the picture does not look too bad. If conditions remain normal till March, GDP growth could be expected to remain at the level of last year, which will be satisfactory considering that the GST has caused a major disruption whose effects in the short run would be negative which will however be offset in the longer run.
Against this background what can be reasonably done? The problem in the economy for the last three years has been lacunae in demand as spending is low key for various reasons. Households are not spending because of cumulative high food inflation in the past. Incomes have not risen as the organized sector has been downbeat and hence capacity for discretionary spending has been impacted (in fact, demonetisation played spoil sport last year at a time when the farm sector and rural economy otherwise did well). In fact most companies have rationalised their salary payments to control profits at a time when growth in sales has been slack.
Investment is not taking place as there is surplus capacity in industry which makes it irrelevant to invest even if rates have come down. Further, banks are not in a position to lend due to the NPA overhang. The debt market is open only to the better rated companies and hence there is low demand for projects. Infra investment too has been stagnant for the same reasons. The government is not in a position to spend as it has the fiscal norms to adhere to. In such a situation, there is little incentive for supply to increase, which has kept GDP growth down.
It must be pointed out that household consumption and corporate investment are the two main drivers of growth which are interlinked. If households spend more on consumer goods, there are strong backward linkages fostered with other industries like steel, plastics, paper etc, which in turn lead to higher demand for machinery which is required to meet this growing demand. Evidently we need to break out from this cycle.
So far the approach has been to have interest rates lowered. Now, interest rates are one component of the growth story and cannot drive economies. If it were that easy then USA would not have taken 10 years to get back on its feet (it has not yet started walking!), and the euro zone and England would not be in a low growth trap for the last 7 years. By overemphasising the role of interest rates, we have missed the hot spot. The focus has to be on spending and one trigger is the government.
The government is an important part of the story as it is the only entity which can borrow money at a low cost and invest in infrastructure. So far the government has stuck to the FRBM norms and introduced a plethora of reforms to improve the ‘doing business environment’. But these are all procedural which is not adequate to revive the economy. One does not do business because the number of clearances required has reduced. There has to be underlying demand for the product or service being provided. Therefore the way out is for direct government action.
When we talk of government, there are two parts – the centre and states. Presently the states are grappling with their challenges of adjusting for the UDAY bonds (the power sector revival scheme) and farm loan waivers. They are not in a position to spend more as their fiscal deficit ratio has reached the threshold levels of 3-3.5 percent as per the FRBM norms. Therefore, the onus is on the central government to take action and there are two ways of going about it.
The first is to increase its spending beyond the 3.2 percent fiscal deficit level. If it is increased by 0.5 percent, it would mean around Rs 80,000 crore which is a good amount in the present context. The government has been bang on target with its capital expenditure in the last three years, which is commendable and hence an additional sum would help further the cause.
Second, is to announce tax breaks on income and corporate taxes. To increase household consumption and corporate investment, tax breaks are necessary, which can lead to lower revenue collections, but could be worth the effort. The government has already said that the GST would be bringing in more tax revenue which is a big positive for the fiscal balances.
All this will help the economy move in the upward direction and compensate for the loss of output especially in the SME sector which has been affected by both demonetisation and GST. Private consumption also needs to pick up and though the monsoons look good, the final impact on farm income is uncertain. Under these circumstances, overall growth will be retained on the 7 percent path this year, but any major jump may not be expected. But we will be better prepared for FY19.
(The writer is chief economist at CARE Ratings. Views are personal)
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Updated Date: Sep 19, 2017 16:13:08 IST