Why the economic slowdown, and how to fix it?: 

Why the economic slowdown, and how to fix it?: 

Context:

• The ministry of finance is caught in a deficit fetishism that seeks to limit the fiscal deficit to 3.5% of GDP

Introduction:

• The growth in gross domestic product (GDP) has plummeted by 3.5 percentage points in just six quarters, from 9.2% in January-March 2016 to 5.7% in April-June 2017.
• The Reserve Bank of India (RBI) has slashed its GDP growth forecast for 2017-18 from 7.3% to 6.8%.
• The latest RBI survey in six metropolitan cities shows eroding consumer confidence, dipping business sentiment in manufacturing, mounting concerns about jobs, and sliding growth perceptions.

Reasons for decelerating growth:

1- Demonetisation: The effects of demonetization such as reduced purchasing power, supply-side inflation with the decreased procurement of raw material, increased transportation costs, delayed payments, etc.  The adverse impact of demonetization on output and employment in the economy, particularly in informal, unorganized sector.

2- Introduction of GST: The consequences of new tax regime such as uncertainty, delayed payments, increase in prices of commodities, increased vows of the informal sector, etc.The GST had an adverse effect on output, in the April-June 2017 quarter.

3- Crisis in Agriculture sector. The GDP per capita in the agricultural sector has been less than one-tenth GDP per capita in the non-agricultural sector.

4-The share of manufacturing sector in GDP and employment is lower.

5- India’ share in industrial production and manufactured exports in the world economy has declined steadily.

6- The GDP is largely supported by the service sector, while employment growth in the economy has been sustained essentially by construction activities and the informal sector both of which have been hurt by demonetization

7- Delayed reforms:  In the long term, Delayed reforms such as Labour reforms (with no exit policy in India) and liberalization discourage foreign investors to set up firms in India.

• The complexities of land acquisition, disputes with major countries over IPR regimes also contribute to the weak business sentiment
• To complicate matters, we have almost nil Privacy laws, an unregulated and haywire e-commerce sector, etc.

Macroeconomic factors responsible for the slowdown:

• Investment and exports have remained unchanged for the past six years.
• Investment (gross fixed capital formation) as a proportion of GDP dropped from 31.8% in 2011-12 to 28.3% in 2013-14 and from 30.4% in 2014-15 to 27.1 in 2016-17.
• Merchandise export as a proportion of GDP was dropped from 15.2% in 2014-15 to 12.2% in 2016-17.
• The US dollar value of merchandise exports has declined.

Why investment and exports are important determinants of economic growth?

1-      Demand Side:

• The three sources of growth from the demand side are consumption, investment, and exports.
• Consumption, whether in the private sector or in the government sector, depends on their respective income levels.
• Investment is decided upon within the economy, while exports, and depends on the world demand for our goods.

2-      Supply side:

• Investment and exports are also critical determinants of growth from the supply side.
• Investment creates capacities or raises productivity, both of which increase output from the supply side.
• Exports raise efficiency and productivity of exporting firms to drive growth in output.
• Investment levels are influenced by factors like investors confidence, bank lending, and infrastructural constraints, but interest rates are by far the most important factor for they determine the profitability of investment.
• The exchange rate is a crucial price that determines the number of rupees earned per dollar of exports and exercises an important influence on the profitability of exporting firms.

What should be done to address the slowdown in the economy?

• The government should use counter-cyclical, expansionary, macroeconomics policies to revive growth.
• Fiscal policy should provide a stimulus, preferably by stepping up public investment.
• Monetary policy should provide a stimulus to private investment by lowering interest rates.

On the expenditure side:

• On the spending side, the government can focus on the following four areas.
• First, provide fresh capital either to existing banks or the new “bad bank”.
• Second, provide some version of a wage subsidy as an incentive to labour-intensive sectors. A version of this was offered to the textile and garment sectors last year but can be improvised and extended. The successful model of Odisha in the garment sector can be replicated.
• Third, give a big boost to affordable housing, by funding land acquisition for the builder, and interest rate subvention for the homeowner. The States of Kerala and Maharashtra have interesting and replicable models.
• Fourth, keep a big focus on exporters, especially in labour-intensive sectors, including agriculture. This includes a weaker exchange rate, quicker refund of GST credit and expanding the scope of the Merchandise Export from India Scheme and Service Exports from India Scheme.

Long-term solutions:

• The various rigidities in the market for land and labour have been holding back the economy for decades now, stopping investors from risking their capital on large-scale projects needed to boost growth. This needs to be addressed to find a viable solution to the problems.
• In the long term, in general, it is the capital formation that revives the economy. Investment is an immediate source of demand.
• Further, the overall unease involved in doing business in the country and the even larger uncertainty looming around the rules that govern the conduct of business have seriously held back growth.
• Effects of new tax regime should be carefully watched.
• Incentives to exporters and increase in budget expenditure to their interest.
• India should be prepared for the impending tightening of monetary policy regime in U.S. and other countries as India has survived the current deficit on account of a strong capital account surplus.
• Also, India should seek to resolve the impending issues with other countries and organizations such as EU(regarding IPR regime and others) so that the India-EU FTA process could be hastened which could prove to be a major boon for the services sector. Similarly, India’s push for a Services pact along with a goods pact in RCEP is a step in the right direction.

Way ahead:

To follow the fiscal deficit to rise by 0.5% of GDP, using that to finance public investment, and to drop interest rates by at least 2 percentage points, which would also help the exchange rate depreciate. This would stimulate investment and promote exports, to revive economic growth.