7 PM | What happened to economy during the first term of Modi | 16th August, 2019

Context:slowing down of economy and its impact

Present economic situation of India:

• The demand for passenger vehicles slowed down during the second half (beginning September 2018) of this financial year because of many reasons-high interest rates, higher fuel prices and lack of credit.
• At a very broad level, demonetization-a radical policy decision-and introduction of Goods and Services Tax-a structural reform-naturally had an adverse impact on the economy.
• Over the last two years, bank credit slowed down dramatically because banks had to make higher provisions for bad loans. With six public sector banks under the central bank’s prompt corrective action framework.
• Poor bank credit, liquidity crisis and high interest rates all created a huge drag on the economy.

Reasons for slowdown of economy:

• Global outlook:The advanced economies are mainly feeling the pinch of high fiscal deficit, worsening unemployment scenarios and deteriorating output growth outlook. The global growth is also likely to face the downward risks due to current uncertainties
• Unemployment persists throughout the globe: Estimates show that more than 210 million people across the globe are unemployed marking an increase of more than 30 million since 2010, three-fourths of which has occurred in the advanced economies.
• In emerging economies, high youth unemployment is starting to gather concern. It may be mentioned that the unemployment situation is more serious in countries in the Middle East, North Africa, European and Developed economies as compared to the South and East Asian countries
• US trade deficit: The escalating high trade deficit values for US trade with the world although did decline visibly with the onset of the global economic crisis, but has regained shortly, to high levels, though still below the pre-Lehman figures.
• Due to rising trade deficit USA taking the measures of tariffs and escalated to trade war, which led rising protectionism throughout the world
• Crisis in agriculture: There is a crisis in agriculture that runs deep. GDP per capita in the agricultural sector has been less than one-tenth GDP per capita in the non-agricultural sector for 25 years. Growth in output is monsoon-dependent. Employment creation is negligible. The outcome is rural distress.
• De-industrialization: The share of manufacturing in GDP and employment is lower than it was 25 years ago. India’s share in industrial production and manufactured exports in the world economy has declined steadily. The beginnings of de-industrialization are discernible
• Investment: 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, so that the investment-GDP ratio dropped by 3.3 percentage points in the last three years.
• Exports:  Merchandise exports as a proportion of GDP were in the range 16-17% during 2011/12-2013/14 but dropped from 15.2% in 2014-15 to 12.2% in 2016-17 (by 3 percentage points). The US dollar value of merchandise exports stagnated during the last three years.

Measures to overcome the slowdown:

• Investment: Investment levels are influenced by many factors such as investor confidence, bank lending, and infrastructural constraints, but interest rates are by far the most important factor for they determine the profitability of investment. So recently RBI reduced the interest rates in right direction
• Rupee exchange rate:The exchange rate is a crucial price that determines the amount of rupees earned per dollar of exports and exercises an important influence on the profitability of exporting firms Between January 2014 and June 2017, the rupee appreciated by 10% in nominal terms and 15% in real terms (adjusted for inflation).
• The poor export performance in this period is no surprise. So government should work bilaterally and control the appreciation of rupee
• Counter-cyclical policies: If there is a slowdown or downturn in an economy, governments should use counter-cyclical, expansionary, macroeconomic 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.
• Sustainable investment: Government borrowing is always sustainable if it is used to finance investment and if the rate of return on such investment is greater than the interest rate payable. So government should promote PPP model investment
• Fiscal space: Allow the fiscal deficit to rise by 0.5% of GDP, using that to finance public investment, and to drop interest rates in steps by at least 2 percentage points, which would also help the exchange rate depreciate. Together, these would stimulate investment and promote exports, to revive economic growth.

Way forward:

• The global economy is undergoing a crisis and has weakened significantly. It is extremely volatile at this stage, investor’s confidence across the globe has fallen sharply and downside risks are emerging each day.
• Against a backdrop of unresolved structural fragilities, a number of shocks have hit almost all the economies. On the other hand, the scope for continued policy support in advanced economies has become much more limited and has, in some cases, been exhausted
• So the government should take appropriate measures to improve the credit cycle through investment and savings and promotion of foreign investment will bring the economy from slowdown in future.

Source: https://www.livemint.com/Opinion/6Lj1pRwzYqCIRJzKDMDrfN/Why-the-economic-slowdown-and-how-to-fix-it.html.