Indian Economy between A Rock and A Hard space

Growth is slowing in India. In July to September this year there were six major economies- Malaysia, Greece, Philippines, Israel, Colombia, Argentina (The Economist December 1) with growth higher than the 6.3 percent India achieved in the April to September quarter of this fiscal. Growth by year end is unlikely to be vastly different. Is this catastrophic? Not really because the key metric today is not just growth but growth with macroeconomic stability- Colombia and Argentina do not score well on this count.

Slaying inflation without hurting nascent growth

Taming inflation remains a global priority. So concerned is the Federal Reserve of the United States that it is willing to risk a serious downturn to stamp out inflation running at 7.7 percent (albeit down a bit from 8.1 percent). The belief is that dragging out the adjustment embeds inflation expectations permanently with even worse effects, so best to take the pain now.

India cannot afford to be that fundamentalist. Tradeoffs exist between protecting nascent growth with lower interest rates and yet managing consumer inflation, which is higher than the permissible range of 2 to 6 percent but declined from 7.41 percent in September to 6.77 percent in October 2022. Also, unlike the US, inflation is significantly supply side driven and not by wage growth. Employment in India remains tepid, unemployment is at 8 percent with young workers and women facing worst outcomes. Manufacturing is just 5 percent above 2019 levels. Construction remains 4 percent below (H1 Gross Value Addition basic, constant prices).

At 6.25 percent, the Repo Rate, at which the Reserve Bank of India lends to banks, remains negative versus inflation at 6.7 percent, the consequence of a surge of cheap money unleashed during the covid pandemic, which is one factor driving inflation. The prudent choice for India is to trail hardening US interest rates to signal our commitment to bear the pain of taming inflation but follow at a relaxed pace with an eye to growth.

Rationalizing indirect tax (GST and import duty) can help but hurts revenue receipts

The fastest way to cool inflation would be lower indirect taxes (GST and import duties) which are regressive anyway, since they do not discriminate between low-income individuals suffering on the downward sloping arm of the K shaped post pandemic growth revival and the few others progressing happily along the upward sloping arm- going up a hill could never have been this pleasurable! Targeted rationalization of tax rates does wonders as illustrated by our performance in corporate tax. Despite effective rate reductions, revenues during April to October are 24 percent above the same period last year.

Versus the budget estimate of 11.1 percent growth in current terms, the outcome in H1 is 15.5 percent (real growth rate at 9 percent plus inflation at 6.49 percent). Tax revenues however increased at 18 percent despite the loss of Rs 390 billion due to the partial roll back in excise tax on fuel – to lower inflation and provide income support to commuters. The continuing healthy revenue collections augurs well for similar tax rationalizations in the upcoming budget giving relief to the average consumer and lowering inflation whilst tapping financially resilient pools of income for additional revenue. Revenue accretions could however slow in the second half this fiscal with real growth slowing.  RBI estimates (MPC December 2022) nominal growth in 2022-23 at 13.5 percent (Real growth 6.8 percent plus inflation 6.7 percent)

Private investment sitting on its hands

Capital investment has improved at 34.7 percent of constant GDP in H1 2022-23 higher than the 33.1 percent in H1 previous year and 31.9 percent in H1 of 2019-20. The catch is that much of the increase is on account of enhanced capital spending by the Union and State governments. Maintaining this elevated public spending level in the absence of high growth (7.5 to 8 percent) clashes with the need to taper down the fiscal deficit from 6.4 percent to 4 percent over the next five years. Note also that elevated fiscal deficit levels feed domestic demand which means higher imports, enlarging the current accounts deficit.

Subdued overseas demand plays to familiar export pessimism

A persistent, high current account deficit is India’s Achilles heel courtesy pervasive export pessimism. Fuel, electronics, gold and gems, machinery, chemicals, edible oil, resins and plastics and non-ferrous metals comprise 75 percent of our imports – reflecting poor natural resource endowments and inadequate process and product R&D in manufacturing. Merchandise (goods) exports grew by 2.5 percent points of GDP between 2019-20 to 2022-23 (first half). With domestic economic activity also increasing, imports grew faster at 5.6 percent points of GDP, widening the current account deficit.

Over the next two years balancing the current account deficit seems unlikely. Export growth faces the headwinds of low overseas demand and domestic hesitation in opening the economy to import competition via free trade agreements. Nevertheless, enhanced gains in services trade are possible with canny positioning and negotiation. Exports should become a national priority and domestic price stability improved by stocking or importing sensitive consumption items like food or fuel to moderate inflation spikes. Lowering logistical and transaction costs for exports was never as important as today.

Are we out of the woods?

The big challenge in growth is to avoid a relapse to the 4 percent growth rate in the pre-pandemic last quarter of 2019-20. Note that the period of illusory growth period due to the “low base effect”- or lower growth levels last year statistically exaggerating this year’s achievements- ends in the next quarter. With more normal base levels in Q3 and Q4 last year, RBI growth projections are back to 4.3 percent in the second half of this fiscal. We are not out of the woods.

Keep targeted welfare flowing

Continuing targeted welfare assistance till growth revives and inflation abates, will not only provide social protection but also boost consumption demand in the interim. Once growth exceeds 6.5 percent next year the additional fiscal space created can be used to cut back the fiscal deficit and lower the current account deficit.

Cutting the costs of outcomes

It is never too early to explore more intrusive management measures to improve the efficiency of public expenditure. Just shoveling more money out of the door without relating expenditure to outputs and outcomes is expensive. Budget reform must enable doing more with less, cut waste, improve project execution, and control administrative expenditure.

The government now has a Capacity Development Commission. Its mandate should be expanded beyond training and skills development to administrative reform functions like retooling and redesigning government systems. The commission’s performance should be measured in systems efficiency enhancement metrics not just the number of training programs conducted.

It is telling that the narrative in the recent elections in Gujarat, Himachal Pradesh and municipal elections in Delhi reflected unabashed clientelist populism – customized welfare takeaways in exchange for votes. Suspended in public disbelief is the grim reality of an economy caught between the rock of a downward fiscal pull of misallocated subsidies and an unsupportive global economic environment. This may prove expensive, even in the short term.

Extracted from the authors opinion piece in The Asian Age December 8, 2022 https://www.asianage.com/opinion/columnists/081222/sanjeev-ahluwalia-indian-economy-between-a-rock-and-a-hard-place.html

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