The road ahead to Viksit Bharat

The entry and exit of capital are two sides of the same coin, and both need to be facilitated while maintaining financial stability

I called last year a year of “Predictable Unpredictabilities”. I guess, this seems to be a prolonged bout. The pandemic has receded. However, globally inflation seems to be sticky, while the pundits, conditioned by an easy flow of funds since the global financial crisis, had called its early phases transitory. This has affected global demand and jobs worldwide. Interest rates are high and protectionism is rearing its ugly head. Funds for startups are inadequate, as these are all headed to the treasuries in the US.

Geostrategic uncertainties along the fault lines in Europe, West Asia, and the South China Sea are threatening to spread. On the domestic front, while the recent parliamentary elections yielded a surprise verdict, the swift formation of a government has dispelled instability concerns. Looking at the economy, India has been a bright spot with four consecutive years of 7 per cent plus growth rate. Quick action by the Reserve Bank of India (RBI) has brought core inflation towards the lower end of the band; however, food inflation is seemingly threatening. India has contributed almost 18 per cent to global growth.

The financial sector is healthy and resilient and digital transactions are surging. The Bengaluru-Chennai belt is seeing the growth of a truly sustainable startup ecosystem capable of giving rise to global-scale startups across many sectors in the country. However, there are certain worrying signs that we must remain cognizant of. Household savings have fallen to a low of 5.1 per cent of gross domestic product (GDP). This could impact credit, slowing growth. Consumption, the mainstay of our growth story, seems to be slowing too, though impact is currently limited and masked by a large government investment in infrastructure.

The government and RBI’s response during and after the pandemic was nimble and effective. However, the debt-to-GDP ratio in India for the general government is above 80 per cent and for the central government at 57 per cent. Though being rupee denominated, the debt does not pose a currency risk in the short run, it does entail substantial debt-servicing liability, restricting room for developmental works.

The FY25 Budget, to be presented this month, would provide the policy direction for at least the next three years, as is the norm for the first Budget of a new government, even though the Narendra Modi-led government has been in place for a decade. The Budget would be expected to lay a road map for Viksit Bharat, the leitmotif of this government.

Tax policy has remained stable over the last three years and is anticipated to continue in that vein. However, personal income tax in India is currently high, with a marginal tax rate of 37 per cent. It’s time to consider reducing this rate, and doing away with surcharges. At a lower level of personal income tax, one would see higher savings and higher consumption, thereby stimulating growth. Any short-term revenue shortfalls could be offset by selling shares of profitable public sector undertakings. The finance ministry must also fulfil its commitment to reducing the fiscal deficit. A lower fiscal deficit would exert downward pressure on inflation and create opportunities for entities other than the government to access credit, thereby boosting growth and employment.

The skill sets for private participation in infrastructure in India have fairly matured over three decades. To enable the private sector to access long-term debt, it’s imperative to develop the corporate bond market. Government of India bonds have already been fully opened for foreign participation, leading to their inclusion in international bond indices. Now, with a comfortable foreign exchange reserve position, India can afford to fully open up highly-rated corporate bonds for external flows. They will be denominated in rupees and give depth to the market, helping to prevent distortion of bank balance sheets.

While India’s record on alleviating poverty has been impressive, this election saw the combined Opposition fighting on the planks of welfarism and employment. The Economist estimates India’s combined welfare spending at about 1.8 per cent of GDP. Going beyond this level could stall the downward trajectory of the fiscal deficit and increase inflation, with limited upside in productivity.

Many policy experts advocate for the growth of manufacturing as the only solution for increasing employment and reducing the load on agriculture in rural areas. I tend to agree with the thesis of the former governor of RBI, who argued in his recent book against mindlessly supporting large industries, as replicating the success stories of China and Southeast Asia may not be feasible. However, I believe that the micro, small and medium enterprises (MSME) sector in India has, like Europe, started to bloom and is sucking in large amounts of credit and driving innovation. Schemes like credit guarantee have proven very useful with a low default rate. Many of them are expected to become part of large-scale supply chains and pull in big industries as well. They would need continued government support through accessible credit and a huge emphasis on skilling.

Another area of focus is services. They can be easily exported and generate large-scale employment. They need support both at the high end, like AI, UI/UX, and at the lower end, such as training nannies, cooks, and care-givers. Increased longevity, better incomes and more women joining the labour force are leading to large scale demand for these services. However, workers in these areas need support by way of enhanced skills, regulated and high-quality intermediaries, universal pension, and health support through the National Pension Scheme and Ayush.

The inevitable growth of services and MSME’s would lead to a large-scale relocation of people from rural to urban areas. While the government has a focus on affordable housing, most of these workers generally need residences near their workplaces as they cannot afford long commutes. A good solution is “rental housing”, which requires policy interventions to facilitate financial flows. This would have a positive impact on allied industries, creating more jobs.

The election also highlighted issues in agriculture. However, minimum support prices limit competition, innovation and cut farmers’ access to markets. In fact, they could receive higher prices if cropping patterns were aligned with pricing signals from the market rather than government intervention. The finance minister in her Budget speech for 2020-21 had laid out a comprehensive plan for agriculture. It needs further push and consensus-building.

Finally, sustaining the current growth momentum between 6.5 and 7 per cent over the medium term would require lots of capital. Financial markets are constantly evolving with new instruments. They would benefit from reduced regulatory burden and a stable fiscal and regulatory regime. A lot would depend on how GIFT IFSC would evolve in the coming years, but we will also have to accept that the entry and exit of capital are two faces of the same coin, and both need to be facilitated while maintaining financial stability. This, in my opinion, is the key to financial reforms. The financial sector for “Viksit Bharat” should be characterised by frictionless operations, and that requires patience, reforms, and policy and regulatory stability.

The writer is chairman of HDFC Bank