January 29, 2018

Both demonetisation and GST, it is obvious, have disrupted the economy – and all evidence suggests the worst may be behind us – but as the Economic Survey points out, what is less appreciated is the role played by interest rates.

As the Survey points out, India grew fast while real rates were falling but, when they started rising after the middle of 2016, while global recovery grew, India faltered. Another deleterious consequence has been the boost to capital flows which make the rupee stronger and boost imports while dampening exports – the Survey has a dig at some parts of the ruling establishment when it says “a strong exchange rate is preferred by those who equate currency strength with broader national strength”. Vital as this is, it is probably of academic interest since RBI seems committed to high interest rates.

The Survey makes a strong case for how the bond markets have misread statements on government borrowings – 0.3ppt of GDP of borrowings, it says, are due to moving away from NSSF to cheaper bonds – but bond yields actually rose since the Survey said a “pause” in the fiscal deficit couldn’t be ruled out. That means bond markets will wait to see the final central government numbers on Thursday and those on state governments later. Given the 3.3% CPI inflation in Apr-Dec, the good news is, despite how bond markets are reacting, there is scope for RBI cutting rates.

While few economists endorse a Demonetisation/GST dividend, the Survey encouragingly points to a bump, saying that after November 2016, 10.1 million filers were added compared with an average of 6.2 million in the preceding six years. While the sharp growth in Apr-Dec direct tax collections corroborates this, as the CEA pointed out, the GST Council has been very responsive in terms of cutting rates – and now, based on Infosys chairman Nandan Nilekani’s suggestion, even tax filing could get easier; as this newspaper has reported, there are also rapid strides in GST software/apps that will reduce the pain. Though not everyone buys the Ghosh & Ghosh results of 5 million new formal sector jobs in 2017 — in the sense that EPFO data shows high employment growth in the UPA years as well – as the Survey points out, the economy is a lot more formal going by the new data; 31% going by EPFO data and 53% going by EPFO data. In the short run, that could hurt, but it is good from the point of view of productivity.

Though the Survey is bullish in terms of its GDP projections, the data it gives makes it clear reviving investment – critical for GDP – is going to be a long haul. India is already 11 years past its investment peak and, as the Survey posits, if the peak of 35.6% of GDP was related to the GDP boom of the 2000s, maybe today’s investment levels are at the normal level. While no other country seems to have gone through such large booms and busts – India itself has never seen anything like this – as the Survey points out (see graphic), “the median country reverses only about 25% of the decline 14 years after the peak”; while this suggests India can recover 4 ppt if it is in the upper quartile, “India is already 11 years past the peak, and its current performance puts it below the upper quartile”.

While the government best hope is quick sale of distressed assets at huge discounts to revive the investment momentum, it is not clear how this will lead to substantial hike in new investments since a large portion of what is on auction are already functional assets. While the government solution is to hike public capex, this will not do the trick. Between FY13-17, total infra capex was projected to rise to Rs 55.7 lakh crore from Rs 23.8 lakh crore in FY07-12, but it rose to only Rs 37.2 lakh crore primarily because private investment didn’t rise – it was to rise to Rs 26.8 lakh crore in FY13-17 from Rs 8.8 lakh crore in FY07-12 but rose to only Rs 12.8 lakh crore. Whether it is in oil or teleco, two sectors with large investment potential, as this newspaper has chronicled, government policy has mostly been unsupportive.

The Survey rightly talks of the need to boost the farm sector, but the usual policies of hiking MSPs won’t do the trick and the government has not been able to get states to create a pan-Indian market; its policies on exports are hostage to domestic inflation and there have been few moves to promote either food processing or foreign investment in food retail. While the Survey does well to point to the impact of global warming, GM seeds are an antidote, but government policy here has been quite regressive.

While the Survey does well to highlight the impact of export incentives to hike exports growth, labour reforms – completely absent so far – have a big role. The top 1% of Indian firms account for 38% of exports while this is around 65% in OECD countries – firm size is a function of poor labour laws.

In the short run, the fact that oil prices will now be acting against the government is a big dampener. The huge tax arrears – Rs 7.6 lakh crore or 4.7% of GDP – and the taxman’s amazingly poor success rate would suggest any sensible government policy would focus on introducing a dispute settlement mechanism which, believe it or not, still does not exist. Similarly, as the Survey stresses, India needs to rapidly ratchet up education/health capacity, but the progress here is glacial. India’s corporate tax rates, similarly, are too high and add to uncompetitiveness and, if India was to divert existing subsidy expenditure to cash transfers for the poor, India would have zero poverty. How much of this agenda will finance minister Arun Jaitley try and fulfil? Wait till Thursday.

[The Financial Express]