The Downward Spiral of the Economy

CONTEXT

The  various macroeconomic indicators of the Indian Economy have been on the downward spiral in the recent past. In such a scenario, reviving the investor sentiment and the demand is the key focus of the Government.

THE ECONOMIC SLOWDOWN

A number of factors could be responsible for this:

Merchandise exports:  One of the major reasons for the current deficit is the greater increase in merchandise imports than exports

Increase import of Gold: Imports increased because of a rise in demand for gold(almost threefold) due to the upcoming festive season and tweaks in trade pacts with countries such as South Korea.

Services -Fall in exports of Services due to domestic industry issues and increased protectionism worldwide.

Agricultural vows :Shortage of agricultural goods and lower farm growth due to erratic monsoons, decreased government spending, hoarding, black marketing, inefficient procurement,etc.

Demonetisation: The effects of demonetisation such as reduced purchasing power, supply side inflation with decreased procurement of raw material, increased transportation costs, delayed payments, etc. Here, the effects on the real estate and construction sector have been specifically marked.

Introduction of GST: The consequences of new tax regime such as uncertainty , delayed payments, increase in prices of commodities, increased vows of informal sector, etc.

Delayed reforms:  In the long term, Delayed reforms such as Labour reforms(with no exit policy in India) and liberalisation 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.

WHAT ARE THE INDICATORS THAT HAVE SLUMPED?

GDP growth declining continuously for six quarters in a row, down from 9.2% to 5.7%.

Investment share of GDP, which creates new factories and businesses for tomorrow, falling for almost five years.

The latest data from the Centre for Monitoring Indian Economy show that even the project pipeline is drying up. Newly announced projects at Rs. 84,500 crore are at a four-year low. Even the stalled projects which have been revived are only 6% during this fiscal year, as against 25% last year.

Banks, despite being flush with deposits (partly thanks to demonetisation), are in no mood to extend new credit. This is because of the increasing burden of bad loans (called non-performing assets, or NPAs). The ratio of NPAs has been continuously going up for five years

A widening Current Account deficit has raised a lot many eyebrows nationally and internationally.

Industrial output growth dropped to 1.2% in July, compared to 4.5% a year earlier.

In addition, retail price inflation jumped to a five-month high of 3.36% in August from 2.36% in July, further dimming the prospects of a monetary stimulus from the Reserve Bank of India to help boost the economy.

HOW CAN THE SLOWDOWN BE HANDLED?

The Keynesian solution

John Maynard Keynes called these the “animal spirits” which guide buyer and investor behaviour. When those spirits are in a downward spiral, the end result could be recession, if not outright depression. His remedy was to suggest countercyclical policy, which has become the hallmark of Keynesianism. This includes an injection of both fiscal and monetary stimulus. This involves increasing government spending or cutting taxes, or both, and decreasing interest rates.

 Handling the Banking crisis

Either you have to write-off the loans and book losses, or ask shareholders to bring more equity capital.

The new bankruptcy code and procedure is promising, but is as yet untested for timeliness and effectiveness.

There is also a suggestion to collect all the bad loans (that is, toxic waste) from the various banks and move them to a freshly capitalised bank, the so-called “bad bank”. The bad bank would focus solely on liquidating the collateral, bringing in fresh owners and managers to run distressed companies.

Once freed from NPAs, the existing banks can resume lending to the healthy sectors. This is a promising idea as well and worth pursuing. The government cannot shy away from funding the rescue of India’s banking. It has to provide capital to the new “bad bank” or to recapitalise the beleaguered public sector banks, where most of the NPAs reside.

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 home owner. 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 organisations 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 services sector. Similarly, India’s push for a Services pact alongwith a goods pact in RCEP is a step in the right direction.