ECONOMIC SURVEY 2016-17 Summary – Chapter 1 : Economic Outlook and Policy Challenges

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Following is the Summary of ECONOMIC SURVEY 2016-17 – Chapter 1 : Economic Outlook and Policy Challenges:

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This year’s Economic survey suggests that shifts in the underlying vision will be needed to overcome the major challenges ahead, thereby accelerating growth, expanding employment opportunities, and achieving social justice.

This year has been marked by several historic economic policy developments.

• Goods and services tax (GST)
• Brexit and US elections.

Demonetisation

A radical governance-cum-social engineering measure was enacted on November 8, 2016.

The aim of the action was fourfold:

• To curb corruption,
• To curb counterfeiting,
• To curb the use of high denomination notes for terrorist activities
• And to curb the accumulation of “black money”, generated by income that has not been declared to the tax authorities.

Other Actions taken

The action followed a series of earlier efforts to curb such illicit activities, including:-

• The creation of the Special Investigation Team (SIT) in the 2014 budget,
• The Black Money Act, 2015;
• The Benami Transactions Act of 2016;
• The information exchange agreement with Switzerland,
• Changes in the tax treaties with Mauritius and Cyprus,
• And the Income Disclosure Scheme.

Demonetisation was also aimed at signalling a regime change, emphasizing the government’s determination to penalize illicit activities and the associated wealth.

The public debate on demonetisation has raised three questions.

• First, broader aspects of management, as reflected in the design and implementation of the initiative.
• Second, its economic impact in the short and long run.
• And, third, its implications for the broader vision underlying the future conduct of economic policy.

Chapter 3 addresses in detail the second question. The broad conclusion is that demonetisation will create short-term costs and provide the basis for long run benefits.

Short-term costs

• Inconvenience and hardship, especially those in the informal and cash-intensive sectors of the economy who have lost income and employment.
• However Survey notes that these costs are transitory, and may be minimised in recorded GDP because the national income accounts estimate informal activity on the basis of formal sector indicators, which have not suffered to the same extent.

Long-term benefits

• in terms of reduced corruption,
• greater digitalization of the economy,
• increased flows of financial savings, and
• Greater formalization of the economy, all of which could eventually lead to higher GDP growth, better tax compliance and greater tax revenues.

These magnitudes will depend importantly on how policy responds to the current situation. The needed actions include-

• remonetizing the economy expeditiously by supplying as much cash as necessary, especially in lower denomination notes;
• complementing demonetisation with more incentive-compatible actions such as bringing land and real estate into the GST, reducing taxes and stamp duties, and
• Ensuring that the follow-up to demonetisation does not lead to over-zealous tax administration.

The third question on the broader vision will also be critical to shaping the medium term trajectory of the economy.

Here the government has taken important steps over the past year.

• the transformational GST bill, which will create a common Indian market, improve tax compliance, boost investment and growth – and improve governance; the GST is also a bold new experiment in the governance of cooperative federalism. In addition, the government:
• Overhauled the bankruptcy laws so that the “exit” problem that pervades the Indian economy–with deleterious consequences highlighted in last year’s Survey–can be addressed effectively and expeditiously;
• Codified the institutional arrangements on monetary policy with the Reserve Bank of India (RBI), to consolidate the gains from macroeconomic stability by ensuring that inflation control will be less susceptible to the whims of individuals and the caprice of governments; and
• Solidified the legal basis for Aadhar, to realise the long-term gains from the JAM (Jan Dhan-Aadhar-Mobile), as quantified in last year’s Survey.

Beyond these headline reforms were other less-heralded but nonetheless important actions.

• The government enacted a package of measures to assist the clothing sector that by virtue of being export-oriented and labour- intensive could provide a boost to employment, especially female employment.
• The National Payments Corporation of India (NPCI) successfully finalized the Unified Payments Interface (UPI) platform. By facilitating inter-operability it will unleash the power of mobile phones in achieving digitalization of payments and financial inclusion, and making the “M” an integral part of the government’s flagship “JAM”-Jan Dhan, Aadhaar, Mobile–
• Further FDI reform measures were implemented, allowing India to become one of the world’s largest recipients of foreign direct investment.

Yet there is a gap between this reality of macro-economic stability and rapid growth, on the one hand, and the perception of the ratings agencies on the other.

Are Credit Rating agencies reliable?

In recent years, the role of ratings agencies has increasingly come into question.

• In the US financial crisis, questions were raised about their role in certifying as AAA bundles of mortgage-backed securities that had toxic underlying.
• Similarly, their value has been questioned in light of their failure to provide warnings in advance of financial crises—often ratings downgrades have occurred post facto.

In the case of India, Standard & Poor’s in November 2016 ruled out the scope for a ratings upgrade on the grounds of its low per capita GDP and relatively high fiscal deficit.

The actual methodology to arrive at this rating was clearly more complex, but are these variables the right key for assessing India’s risk of default?

1. Consider first per capita GDP. It is a very slow moving variable. Lower middle income countries experienced an average growth of 2.45 percent of GDP per capita (constant 2010 dollars) between 1970 and 2015. At this rate, the poorest of the lower middle income countries would take about 57 years to reach upper middle income status.
2. Consider next fiscal variables. The practice of ratings agencies is to combine a group of countries and then assess comparatively their fiscal outcomes. So, India is deemed an outlier because its general government fiscal deficit ratio of 6.6 percent (2014) and debt of 67.1 percent are out of line with its emerging market “peers”.

But India could be very different from the comparators used by the ratings agencies.

• Many emerging markets are struggling. But India has a strong growth trajectory, which coupled with its commitment to fiscal discipline
• Even if this scenario does not materialise, India might still be able to carry much more debt than other countries because it has an exceptionally high “willingness to pay”, as demonstrated by its history of not defaulting on its obligations
• India also compares favourably to other countries on other metrics known to be closely related to the risk of default. Consider the contrast with China. In 2009, China launched an historic credit expansion, which has so far seen the credit-GDP ratio rise by an unprecedented about 63 percentage points of GDP, much larger than the stock of India’s credit-GDP
• In December 2010, it increased China’s rating from A+ to AA- and it has never adjusted it since, at the same time, Chinese growth has slowed from over 10 percent to 6.5 percent.
• In contrast, India’s ratings have remained stuck at the much lower level of BBB-, despite the country’s dramatic improvement in growth and macro-economic stability since 2014.

 

Structural Challenges in Indian Economy

• Chapter 9 discusses India’s extensive efforts at redistribution. The central government alone runs about 950 central sector and centrally sponsored schemes and sub-schemes which cost about 5 percent of GDP with intrinsic limitations in terms of the effectiveness of targeting.
• Even on the GST, concerns about ensuring low tax rates for essentials, risks creating an unduly complicated structure with multiple and excessively high peak rates, thereby foregoing large services efficiency gains
• On state capacity, delivery of essential services such as health and education, which are predominantly the preserve of state governments, remains impaired.
• The competitive federalism has been a powerful agent of change in relation to attracting investment and talent, it has been less in evidence in relation to essential service delivery like on health and education there are insufficient instances of good models that can travel widely within India and that are seen as attractive political opportunities. Competitive populism needs a counterpart in competitive service delivery.
• Political dynamic is still in ambivalence toward the private sector and property. This ambivalence is manifested in:
  • the difficulties in advancing strategic disinvestment;
  • the persistence of the twin balance sheet problem—over-indebtedness in the corporate and banking sectors—which requires difficult decisions about burden-sharing and perhaps even forgiving some burden on the private sector;
  • The legacy issues of retroactive taxation, which remain mired in litigation even though the government has made clear its intentions for the future;

 

• Agriculture, where the protection of intellectual property rights, for example in seeds, remains a challenge;

 

• Reform in the civil aviation sector, where despite decades of failure there are still dreams of making a world class airline by the government.

 

• In the fertilizer sector, where it is proving easier to rehabilitate unviable plants in the public sector rather than facilitate the exit of egregiously inefficient ones; frequent recourse to stock limits and controls on trade in agriculture, which draws upon the antiquated Essential Commodities Act, and creates uncertainty for farmers.

In each of these examples, there may be valid reasons for the status quo but overall they indicate that the embrace of markets even in the modest sense of avoiding intrusive intervention, protecting property rights, disposing of unviable public sector assets and exiting from areas of comparative non- advantage, and allowing economic agents to face market prices—remains a work-in- progress.

Global Challenges

• The impact of BrExit and the US elections risk unleashing paradigmatic shifts in the direction of isolationism and nativism.
• Given that India’s growth ambitions of 8-10 percent require export growth of about 15-20 percent, any serious retreat from openness on the part of India’s trading partners would jeopardize those ambitions.
• The decline in oil had imparted dynamism by increasing private consumption and facilitating public investment, this year that important source of short-term dynamism may be taken away as international oil prices are now on the rise.
• The implied change in expectations of US fiscal and monetary policy will impact on India’s capital flows and exchange rates.
• The medium-term political outlook for globalization and in particular for the world’s “political carrying capacity for globalization” looks weak. This changed outlook will affect India’s export and growth prospects.
• Developments in the US, especially the rise of the dollar, will have implications for China’s currency and currency policy. If China is able to successfully re-balance its economy, the spill over effects on India and the rest of the world will be positive. On, the other hand, further declines in the Yuan, even if dollar-induced, could interact with underlying vulnerabilities to create disruptions in China that could have negative spill overs for India.

Economic Outlook: The numbers that matter

• Real GDP growth in the first half of the year was 7.2% and the economy was buoyed by government consumption as the 7^th pay salary recommendations were implemented.
• Sector-wise, Agriculture showed improvement due to good monsoon.
• Retail inflation measured by CPI stood at 3.4% for December 2016. There was fall in agricultural prices, especially of pulses due too bountiful monsoons and in part5 due to demonetization.
• WPI was dangerously low in August 2015 at -5.1%, bounced to 3.4% at the end of Dec 2016
• CPI outlook for the whole year to be below the RBI’s target of 5%.
• The GDP growth in 2016-17 will dip to 6.5% down from 7.6% in 2015-16.
• Economic growth to rebound to 6.75-7.5% in 2017-18.
• Agriculture growth is expected to be at 4.1% in 2016-17 up from 1.2% in last fiscal.
• There will be windfall gain from PradhanMantriGaribKalyanYojana (PMGKY) and low oil prices.
• Fiscal deficit target of 3.5% of GDP will be met for this year.
• The state governments are struggling. Their consolidated deficit has increased steadily in recent years, rising from 2.5% to 3.6% in 2015-16, partly because of the UDAY scheme.

External Sector

• CAD declined to 0.3% in first half of 2016-17.
• Foreign Exchange Reserves $360 billion can cover 12 months of imports comfortably.
• Net FDI inflows grew 3.2% in second quarter of 2016-17
• Trade deficit has declined by 23.5% in April-Dec 2016 due to contraction in imports. But Software exports slowed and financial services declined in 2016-17.
• Net private remittances declined by $4.5 billion due to oil prices decline which affected the inflows from the Gulf region.

The macroeconomic policy stance for 2017-18

An economy recovering from demonetisation will need policy support.

• The banking system will benefit from a higher level of deposits due to demonetization.
• Thus, market interest rates—deposits, lending, and yields on g-secs—should be lower in 2017-18 than 2016-17. This will provide a boost to the economy.
• Fiscal policy is another potential source of policy support.
• For the use of the fiscal windfall the PMGKY should be deployed to strengthening the government’s balance sheet rather than being used for government consumption, especially in the form of programs that create permanent entitlements.
• In this light, the best use of the windfall would be to create a public sector asset reconstruction company (discussed in Chapter 4) so that the twin balance sheet problem can be addressed, facilitating credit and investment revival;
• Or toward the compensation fund for the GST that would allow the rates to be lowered and simplified; or toward debt reduction. The windfall should not influence decisions about the conduct of fiscal policy going forward.

The most important reforms to boost growth will be structural.

• Strategic disinvestments, tax reforms, subsidy rationalization, create a public sector asset reconstruction company.

Another area of reform relates to labour.

• Given the difficulty of reforming labour laws per se, the thrust could be to move towards affording greater choice to workers which would foster competition amongst service providers.
• Choices would relate to: whether they want to make their own contribution to the Employees’ Provident Fund Organisation (EPFO); whether the employers’ contribution should go to the EPFO or the National Pension Scheme; and whether to contribute to the Employee State Insurance (ESI) or an alternative medical insurance program.

On the expenditure side, the results in Chapter 9 make clear that existing government programs suffer from poor targeting.

• One radical idea to consider is the provision of a universal basic income.
• But another more modest proposal worth embracing is procedural: a standstill on new government programs, a commitment to assess every new program only if it can be shown to demonstrably address the limitations of an existing one that is similar to the proposed one;
• And a commitment to evaluate and phase down existing programs that are not serving their purpose.

Redistribution: Universal Basic Income (UBI) as a radical new vision

Chapter 9 discusses India’s extensive efforts at redistribution. The central government alone runs about 950 central sector and centrally sponsored sub-schemes which cost about 5 percent of GDP with intrinsic limitations in terms of the effectiveness of targeting.

• Often the very districts that house the most number of poor are the ones facing the greatest shortfall in the allocation of.
• This misallocation has consequences: it results in exclusion of the deserving poor from access to government welfare benefits, leakages to non-poor and benefits to corrupt local actors.
• One of the key problems with many programs is that the take-up and effectiveness of targeting will be correlated with a state’s institutional and implementation capacity.
• States such as Tamil Nadu and Andhra Pradesh, which do not necessarily have the largest number or proportion of poor avail themselves of the program to a greater extent than say Bihar which has many more poor people and a higher poverty rate. This is not an unusual phenomenon but almost intrinsic to anti-poverty and social programs.
• In such cases, the risks of making “exclusion errors”- that is leaving out the really deserving and needy — are high.

For this and other reasons, the Survey (in Chapter 9) argues that serious consideration be given to the new idea of a universal basic income as a more effective way of achieving Mahatma Gandhi’s objectives of “wiping every tear from every eye.”

• A UBI has the merit that it will not necessarily be driven by take-up capability from below but given from above to all the deserving. In that sense, it is less likely to be prone to exclusion errors.
• And by directly transferring money to bank accounts, and circumventing multiple layers of bureaucracy, the scope for out-of- system leakages (a feature of PDS schemes) is low.

Two Risks to India’s Competitiveness

• Sharp rise in the dollar is expected with a corresponding decline in the currencies of India’s competitors, notably China and Vietnam given India’s need for exports to sustain a healthy growth rate, it is important to track India’s competitiveness.
• A second reason to review India’s competitiveness is the rise of countries such as Vietnam, Bangladesh, and the Philippines that compete with India across a range of manufacturing and services.

But India has managed well to maintain export competitiveness despite capital inflows and inflation that has been greater than in trading partners. Reflecting this, India’s global market share in manufacturing exports has risen between 2010 and 2015.

Going forward, the policy implication is that if India is concerned about competitiveness and the rise of exporters in Asia, it should monitor an exchange rate index that gives more weight to the currencies of competitors.

Climate Change and India

The Paris Agreement on climate change in December 2015 has been one of the shining recent examples of successful international cooperation. The focus will now shift to implementing the agreements.

There is universal agreement that a key component to tackling climate change will be to price carbon. How has India fared on this score?

Steps taken by India to curb Carbon emission

Since June 2014, when international oil prices started declining, India has increased the petrol tax over 150 percent.

In contrast, the governments of most advanced countries have simply passed on the benefits to consumers, setting back the cause of curbing climate change.

As a result, India now outperforms all the countries except those in Europe in terms of tax on petroleum and diesel.

India’s reliance on fossil fuels remains well below China (the most relevant comparator) but also below the US, UK and Europe at comparable stages of development.

 

ENSURING WOMEN’S PRIVACY

Lack of access to sanitation is widespread and well-documented. In 2011, the Census reported that more than half of the country’s population defecated in the open. More recent data shows that about 60 percent of rural households (Ministry of Drinking Water and Sanitation- 2017)

There are disproportionate burden that falls on women and girls due to deficiencies in sanitation facilities.

This burden on women can take several forms:

• Threat to life and safety while going out for open defecation,
• Reduction in food and water intake practices to minimize the need to exit the home to use toilets,
• Polluted water leading to women and children dying from childbirth-related infections,
• And a host of other impacts.

Women’s personal hygiene is therefore important not just for better health outcomes but also for the intrinsic value in conferring freedom that comes from having control over their bodies, a kind of basic right to physical privacy. Put differently, impeded access may well be creating “gender-based sanitation insecurity.”

 

Given this general lack of access, what additional challenges do women face?

A rapid study conducted in 2016 by WASH Institute and Sambodhi for this Economic Survey provides some insight.

The Disproportionate Burden on Women

Households without toilets: For the majority of households without toilets, the Rapid Survey suggests some worrisome trends:

• 76 percent of women had to travel a considerable distance to use these facilities.
• 33 percent of the women have reported facing privacy concerns and assault while going out in the open.
• In the face of these considerable risks, the number of women who have reduced consumption of food and water are 33 percent and 28 percent respectively of the sample.
• Apart from illnesses, disruptions and deficiencies in the short -term, reduced food and water intake also causes severe long-term debilitating impacts on health, and impedes in cognitive development of girls and infants.
• Many studies (Singh et. al 2008; Curtis and Minjas 1985) have similarly emphasized that women and men going out into the open have to cope also with exposure to natural elements, snake- bites, etc.

Household with toilets:

• In households with toilets, women report far greater use of these in-home facilities than men, suggesting that there may be a greater demand amongst women.
• Surveyors found a revealed preference for households to defecate in the open because of a variety of factors (caste and soak pit latrines, especially).
• women in households with toilets, 62 percent reported use of the toilet “always” (only 52 percent men reported exclusive usage in such households).

India’s soon to recede Demographic dividend

India, however, seems to be in a demographic sweet spot with its working-age population projected to grow by a third over the same period; always remembering that demography provides potential and is not destiny.

• Large working age populations relative to the overall population appear to benefit from greater economic dynamism.
• Younger populations are more entrepreneurial (adding to productivity growth); tend to save more, which may also lead to favourable competitiveness effects.
• It gives a larger fiscal base because of economic growth and because there are fewer dependents (children and elderly) for the economy and government to support.

Distinctive Indian Demography

• India’s demographic cycle is about 10-30 years behind that of the other countries, indicating that the next few decades present an opportunity for India to catch up to their per capita income levels.
• India will remain close to its peak for a much longer period than other countries.
• India is the large heterogeneity among the states in their demographic profile and evolution. There is a clear divide between peninsular India and the hinterland states.
• The peninsular states exhibit a pattern that is closer to China and Korea, with sharp rises and declines in the working age population.
• In contrast, the hinterland states will remain relatively young and dynamic, characterized by a rising working age population for some time plateauing out towards the middle of the century.

Demographically speaking, therefore, there are two India, with different policy concerns:

• a soon-to- begin-ageing India where the elderly and their needs will require greater attention;
• and a young India where providing education, skills, and employment opportunities must be the focus.

Of course, heterogeneity within India offers the advantage of addressing some of these concerns via greater labour mobility, which would in effect reduce this demographic imbalance.

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