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Every government or party can be blamed for this. They target the top and the bottom of the society. The top consists of industrialists, companies and in the context of India and some other countries, foreign institutional investors who get the best treatment and tax sops because they aid growth and create jobs. The argument: Without the lure of profits, they will not invest. The bottom also gets the best sops and tax benefits because they are the downtrodden who need to be hand-held constantly.
So, the middle-class bears the brunt. They are taxed more, their investments don’t earn high returns and the high inflation-interest scenario is always straining their budgets.
There is a case for empowering the middle class. Why? Simply because they are willing to spend and if they have enough money in their hands, they can revive growth faster. For decades, it has been argued (mostly by Keynesians) that when the economy is in a bad shape, pay labourers to dig and fill up a hole. They will spend on essentials which will generate demand for companies and the economy will revive. We have been following this model for years. MNREGA, for one, has put money in the hands of the people below poverty line. They have spent and kept certain sectors alive. But it isn’t doing much for the overall economy.Even if one goes by the traditional velocity of money argument, I doubt things will improve by only giving money to the rich and poor. And given the state of the economy, there is little time to go the roundabout way of – one rupee spent will lead to expenditure of four or ten rupee (multiplier effect).
There is a case for big spends in goods like houses, cars, spend on malls, buy clothes and even travel to ensure that there is growth. This will lead to growth for a wider number of companies and sectors that can kick-start growth.
Will the middle class do it? It just may, provided there is incentive. In fact, they are already doing so. As a recent media report points out, the average monthly spend on credit cards is up 42% – from Rs 4,462 to Rs 6,322 – in two years. Consumers are lapping up the latest phones or gadgets which cost upwards of Rs 30,000 and credit card companies are offering zero interest schemes on them. In other words, despite an overall slowdown, absence of substantial salary hikes and high inflation, middle-class India is spending.
Imagine what they can do, if there are incentives to spend bigger. For instance, if someone is buying a first home, give him a fixed rate of interest of 5% (many foreign banks give loans at 6-8%to their employees) and let this window be open for one year. Many fence sitters might just decide to take this plunge.
Of course, banks will be quick to point out that the cost of funds is higher. The answer lies in making second and third homes more expensive. Charge 12-15% for the purchase of a second property on loan. A surprising high number of investors are holding on to property by buying them. Also, take away the interest rate benefit on second homes (there is no tax on the interest paid of a second property). In fact, double or quadruple property taxes as the number of houses increase.
If these do not solve the issue of cost of funds, allow Indian banks to raise capital from abroad to fund home loans. If foreign institutional investors can borrow money at cheap rates and buy stocks in India (which actually does not create any physical asset), allow Indian banks the arbitrage game. Similar benefits can be given for buyers of first cars.
Helping the poor through food security bill is quite unlikely to increase growth substantially. Similarly, companies which have been crying foul over high interest rates only wish to restructure their loans at lower rates and one wonders, how many of them will make fresh investments. Give them demand for their goods and they will forget about interest rates.Of course, opponents will say that US did the same and it led to financial meltdown. But that is why we need checks and balances. The low interest rate is for the first home, the first car and so on, one cannot make unlimited use of these benefits.
Incentives to spend or as the economists say, pump priming is not bad per se. But in times when faster turnaround is required, incentivising the middle class may bear more fruit.
