Facing another slowdown

Finance ministry has at last admitted the economy is slowing - so what will govt do?

In spite of optimistic forecasts about a packed “100-day agenda” for the re-elected government of Prime Minister Narendra Modi, it is unlikely that a new and comprehensive reform agenda will be revealed. This is for three basic reasons. First, the personnel involved do not inspire these expectations. Finance Minister Nirmala Sitharaman, for example, while unquestionably competent, did not distinguish herself as a reformist in her previous stint in an economic ministry, namely the Union ministry of commerce. Second, there is a rhetorical reversal implicit in revealing a reform agenda which this government will struggle with. Over the course of an election campaign, it argued that it had already implemented far-reaching reform and that the economy was therefore prospering. To now inform the nation that major economic reform needed to be instituted would constitute something of a contradiction, and the government’s messaging mavens would not be pleased. Finally, it is unlikely that decision-makers see the need for reform in the first place, given that the government’s handling of its first term resulted in an increased majority. 

In many countries, elections are fought over specific policy programmes. Some parties or candidates wish to address health care or tax evasion through one set of policies; their opponents have a different view on which policies would work, and what the priorities are. Unfortunately, the election that India has just undergone, like the one before it, was in fact relatively free of discussion of these matters. As a consequence, we had no idea in 2014 what Prime Minister Narendra Modi would do, and no idea what he will do now. This is a weakness of India’s democratic process that must be accepted. It means not only that there is little scrutiny of a policy agenda before a politician is given power, but also that frequently a policy agenda is only created after the politician gains power — and valuable time is lost in the process. 

What is important to note is that the Union finance ministry has at last admitted that growth is slowing in the Indian economy. There have been three successive quarters of slowing economic growth, according to the latest numbers for gross domestic product or GDP. This means that, at the very least, processes must kick in within the government to address this slowdown. The last slowdown under Narendra Modi happened at a politically sensitive time, when the government was trying to manage the narrative, so it was largely denied. This one has a better chance of being addressed. Even if there was no real incentive or desire to reform earlier, the prospect of a slowdown might at least galvanise the government into some moves that could benefit the economy in the long term. 

Illustration by Binay Sinha

The finance ministry blames the slowdown on three components of GDP: Private consumption, fixed investment and exports. This mirrors the general belief that, while exports and private investment have been in crisis for some years, consumption and state investment was keeping the economy buoyant. That is, however, an unsustainable model over time. Governments run out of money and fiscal space if they try to prop up economies alone; and consumption cannot boom in the absence of other strong fundamentals. 

The mistake would be to, at this stage, focus on reviving consumption rather than the other two components named by the finance ministry. It is the long-term structural damage done to investment and to exports that needs to be addressed, not the consequent failure of consumption.

When it comes to private investment, the simplest diagnosis, and the one that many in government continue to believe, is that the problem lies with the financial sector — in particular, banks. Like all governments before it, this one also believes that lower interest rates are a panacea. If only interest rates were lower than all the problems that it has created through its own actions for business would be rendered irrelevant. Unfortunately, banks are slow to lower their interest rates even when the Reserve Bank of India is willing to play along and cut the headline rate. The problem, however, is that cleaning up the banking system, in such a manner that they are able to more easily transmit lower interest rates to their customers, is not a straightforward positive from the point of view of the government. On the one hand lower rates and healthy banks would be good for investment in the long term. But, on the other hand, creating healthy balance sheets for banks would require continued strictness about bad debt. This nobody is prepared to countenance — witness the RBI’s decision to relax its requirements for the reporting of bad debts. The long and short-term solutions are at war in this case. 

Exports also might suffer from a misdiagnosis of the structural problem. Commerce Minister Piyush Goyal is absolutely right to declare that the central problem for exports is that they are uncompetitive. But the question is: Why? Mr Goyal further argued that interest cost issues were a problem for exporters. No doubt the price of capital is high for many of them, especially when compared to those from places with non-market financial structures like the People’s Republic of China. So, also, are the prices of other basics: Land and skilled labour. The government has done well to improve the supply of power, and of basic infrastructure. But this has clearly not been enough to revive exports, which have been largely flat in real terms through the National Democratic Alliance’s tenure. A revival in exports could be sufficient to push the incentive to invest higher as well, and permanently pull India out of its current slowdown. But that will need competitiveness-boosting reform that helps all tradeable sectors — not some tinkering around the edges with subsidies, interest or tax rates for exporters. India has waited too long for central reform of land and labour law. It cannot afford to wait much longer. 
 

mihir.sharma@bsmail.in; Twitter: @mihirssharma