The Narendra Modi government completes two years in office tomorrow. How has it done with regard to the management of the economy? Available macroeconomic indicators suggest a mixed picture.
Economic growth in the last two years has stayed above seven per cent. The growth in the last two years of the previous government ranged between 5.6 and 6.6 per cent. The Modi government has also reined in its fiscal deficit, which was down at 4.1 per cent of gross domestic product (GDP) in 2014-15 and 3.9 per cent in 2015-16. The Manmohan Singh government’s fiscal deficit in its last two years had hovered around 4.4 to 4.9 per cent.
Government expenditure on subsidies has also been on a decline in the last two years, even as financial allocations for infrastructure have seen an increase. New initiatives in the roads, railways and energy sectors have already started making an impact to bring about a recovery in India’s infrastructure that suffered hugely from policy paralysis in the last two years of the Manmohan Singh government. These have been supplemented by the increased coverage of the Aadhaar scheme, expeditious roll-out of the direct benefits transfer scheme for cooking gas supplies and the launch of the Jan Dhan Yojana to ensure financial inclusion, and hopefully access as well.
What about prices? Wholesale prices fell in 2015-16 and saw a marginal rise of two per cent in the previous year, compared to six to seven per cent wholesale inflation in 2012-14. Retail inflation too came to below six per cent, while in the last two years of the Manmohan Singh government it had stayed above nine per cent. The current account deficit during the Modi government’s tenure has stayed at around 1.3-1.4 per cent of GDP, much more benign than 1.7 per cent in 2013-14 and 4.8 per cent of GDP in 2012-13.
However, there should be a caveat here. The decline in the inflation rate as well as the improvement in the current account balance is largely due to a steep fall in international crude oil prices. The average crude oil price for the Indian basket was estimated at between $105 and $107 a barrel in the last two years of the Manmohan Singh government. In 2014-15, the average crude oil price for the Indian basket declined 20 per cent to $84 a barrel and fell by another 45 per cent to average at $45 a barrel in 2015-16. Add to this the falling international price of gold and coal, and you would then understand why the Modi government should not take the entire credit for bringing down inflation or the current account deficit.
On the foreign trade front, the news has been unambiguously bad. Exports contracted for the second consecutive year in 2015-16. Imports too fell thereby bringing down the total trade deficit. But that is hardly any consolation since the rate of fall in non-oil imports showed the tepid demand in the domestic sector, triggering another area of concern for the economy. Although foreign direct investments have seen a big increase in the last two years, domestic investment proposals have been falling in the same period and the current level of capacity utilisation at around 73 per cent is an indication that an investment demand recovery is nowhere near sight. Industry is unlikely to commit fresh investments in a significant way unless capacity utilisation is close to 90 per cent. No official numbers are available, but jobs growth could not have been promising either since investments are yet to see a significant pick-up.
The financial sector continues to be in a mess, though the Modi government has initiated a set of new schemes to reduce the banking stress, particularly among state-owned banks. But this is going to be a long haul. The passage of the bankruptcy code will be of some help, but unless major steps are taken to reduce government stake in public sector banks, mere recapitalisation or cleaning up of stressed accounts would only be palliatives without any guarantee that such problems would not recur.
So what are the lessons that the Modi government should draw from its performance in the last two years? One, it must learn the art of expectations management. Its promise of dramatic economic recovery once it was elected to power was completely imprudent. No economy of India’s size and diversity can be turned around in a short time of two years, particularly when the government has to deal with an Opposition, whose numbers in the upper house of Parliament are larger than those of the ruling party. The level of stress in the economy was underestimated and it was necessary for the government to dispel the impression early on in its tenure that there was no magic wand by which the ills of the economy could be cured. Not doing that has turned out to be a costly mistake. The government may have notched up many successes, but invariably these are being judged against the promises made.
Two, the Modi government must recognise the increasing power of the states. There are several economic laws that need to be reformed, but many of them are under the domain of the state governments. Even if the Centre passes the laws, it would be necessary for the states to approve them too before they could make a difference. In any case, the combined annual expenditure of all the state governments is now much higher than what the Union government spends in a year. This was not so until 2011-12. The Modi government must take states on board to ensure that the proposed reforms are implemented by them, so that cooperative federalism can spur competition for those that do not wish to embrace the reformist laws.
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