INDIA’S Two Speed Economy
India is a “two-speed economy”, according to many economists.
The term is used to describe economic models where one section of a country’s economy is booming, while others are lagging behind.
- Earlier it was seen in Australia, where the mining and commodities boom shielded the pain of sectors such as manufacturing and retail.
- In China, where the export and manufacturing sectors overshadowed other issues.
When it comes to India, there is a strong case for a two-speed economy with high growth rates masking the underlying inefficiencies.
The key concern is that such an economic model is unbalanced and risks hurting growth in the long run. But structural reforms may slowdown the economy. It is a conundrum that needs to be solved before the crisis hits.
India needs to maximize its growth potential over the next 16 years. That is because come 2038, India’s demographic dividend will tilt in favour of dependants, both old and very young.
India requires a growth boost in the short term as well as medium to long-term reforms.
How is it being tackled?
The Indian government has taken several measures:-
- The two biggest ones have been the passing of the goods and services tax (GST) Bill, the biggest reform in India’s indirect tax structure, and the more recent demonetization move.
- The key objectives of both these moves is to bring the informal economy and the money it generates—commonly referred to as “black money”—into the formal fold. The moves aim to get unaccounted cash back into the banks, as well as have more Indians pay the tax they owe.
- Before that, the reforms for financial inclusion like Jan Dhan Yojana, Agricultural Insurance, Pension reforms and MUDRA Banks for credit to the people in informal economy.
- Other structural reforms being undertaken like Labour reforms, removal of FDI regulations, easing of doing business.
Measures to boost growth
- Cutting taxes for small businesses and low- and middle-income earners.
- 25% funding increase for the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA).
- Measures include higher agricultural credit, higher allocation for irrigation projects and a crop-insurance scheme.
How will it repair the two-speed economy?
- The informal economy becomes formalised, growth in these sectors will stabilize in the long run. At the same time, as more Indians start to pay their share of taxes, government revenue will rise — help finance the much needed improvements in infrastructure across the country which has been a key concern for companies investing in India.
- The knock-on effect from that will likely be more foreign investment flowing into the country, which will generate more jobs, boost the middle class and trigger a cycle of sustained economic growth.
- The tax cuts will put more cash in the hands of these businesses and households and giving them more cash to spend—be that for investing back in their business to boost growth, or to reward their employees—will have a direct tangible impact on the economy.
- Focus on rural India, farmers and rural-work programme will generate more employment in rural areas.
- Labour laws will help reduce the compliance burden and will be a big positive, especially for the manufacturing sector. More about Labour reforms here.
Suggestions for near term policy measures
- Finding resources to adequately capitalize public-sector banks, the government will need to work with the RBI to resolve the bad loan problem at an accelerated pace, as this is perhaps the biggest impediment to investment and growth revival. (Twin Balance Sheet problem, discussed in the Economic Survey)
- Government’s capital expenditure should increase by 25% in the next fiscal.
- The government will need to complete the necessary legislative requirements in the current session of Parliament and ensure that the GST is implemented smoothly. To be sure, there will be fiscal implications if the GST is not implemented properly as the Central government is bound to compensate the states for revenue losses. The need for a large compensation can affect fiscal calculation and end up disturbing the capital expenditure plans of the Central government, thus becoming a drag on growth.
- The gains from Demonetization should be used to push capital expenditure—including in rural areas—which will help augment growth in the medium to long run instead of spending on giving subsidies or alms which may have tangible political benefits for ruling party.
- Reduce corporate tax across the board. The government would do well to work on a timeline as to how and when the exemptions will be removed and the corporate tax rate will be brought down to 25%. This will provide clarity and will help boost investment. This will also lift sentiment in the financial market and help companies mobilize resources at more favourable terms.
- The government should also work on reforms in other parts of the factor market. For instance, India needs a vibrant corporate debt market. Despite numerous studies and committee reports, progress on this front has not been as desired. It is time the government takes the lead and works with financial sector regulators to give this project a decisive push.
- Need to chalk out a detailed plan to meet disinvestment targets which have been missed by the governments from last 3-4 years.
India needs this two-speed economy for both economic and political reasons.
- Economically, the boost in domestic consumption will lead to faster growth, which will help make up for the slow speed of the positive impact of structural reforms like GST and demonetization.
- Politically, it will help cushion the short-term pain and make it easier for the government to continue its reform agenda.