Economic Outlook, Prospects and Policy Challenges
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(1) Inflation has declined by over 6 percentage points since late 2013 and the current account deficit has declined from a peak of 6.7 percent of GDP (2012-13) to an estimated 1.0 percent in the coming fiscal year. This is an extremely important positive turn for the economy. Moreover the foreign portfolio flows have stabilized the rupee, exerting downward pressure on long-term interest rates, reflected in yields on 10-year government securities, and contributed to the surge in equity prices.
(2) After a nearly 12-quarter phase of deceleration, real GDP has been growing at 7.2 percent on average since 2013-14, based on the new growth estimates of the Central Statistics Office. Notwithstanding the new estimates, the balance of evidence suggests that India is a recovering, but not yet a surging, economy.
(3) From a cross-country perspective, a Rational Investor Ratings Index (RIRI) which combines indicators of macro-stability with growth, illustrates that India ranks amongst the most attractive investment destinations.
(4) Several reforms have been undertaken and more are on the anvil. The introduction of the GST and expanding direct benefit transfers can be game-changers.
(5) In the short run, growth will receive a boost from the cumulative impact of reforms, lower oil prices, likely monetary policy easing facilitated by lower inflation and improved inflationary expectations, and forecasts of a normal monsoon in 2015-16. Using the new estimate for 2014-15 as the base, GDP growth at constant market prices is expected to accelerate to between 8.1 and 8.5 percent in 2015-16.
(6) Medium-term prospects will be conditioned by the “balance sheet syndrome with Indian characteristics” (this phrase has been used because Indian companies are suffering from a classic case of “debt overhang” after an investment bubble funded by borrowings and the failure to commission such large investments) that has the potential to hold back rapid increases in private sector investment. Private investment must be the engine of long-run growth. However, there is a case for reviving targeted public investment as an engine of growth in the short run to complement and crowd-in private investment.
(7) India can balance the short-term imperative of boosting public investment to revitalize growth with the need to maintain fiscal discipline. Expenditure control, and expenditure switching from consumption to investment,will be key.
(8) The outlook is favourable for the current account deficit and its financing. A likely surfeit, rather than scarcity, of foreign capital will complicate exchange rate management. Reconciling the benefits of these flows with their impact on exports and the current account remains an important challenge going forward.
(9) India faces an export challenge, reflected in the fact that the share of manufacturing and services exports in GDP has stagnated in the last five years. The external trading environment is less benign in two ways: partner country growth and their absorption of Indian exports has slowed, and mega-regional trade agreements being negotiated by the major trading nations in Asia and Europe threaten to exclude India and place its exports at a competitive disadvantage.
(10) India is increasingly young, middle-class, and aspirational but remains stubbornly male. Several indicators suggest that gender inequality is persistent and high. In the short run, the renewed emphasis on family planning targets,backed by misaligned incentives, is undermining the health and reproductive autonomy of women.
Fiscal Framework
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(1) India must adhere to the medium-term fiscal deficit target of 3 percent of GDP. This will provide the fiscal space to insure against future shocks and also to move closer to the fiscal performance of its emerging market peers.
(2) India must also reverse the trajectory of recent years and move toward the golden rule of eliminating revenue deficits and ensuring that, over the cycle, borrowing is only for capital formation.
(3) Expenditure control combined with recovering growth and the introduction of the GST will ensure that medium term targets are comfortably met.
(4) To ensure fiscal credibility and consistency with medium-term goals, the process of expenditure control to reduce the fiscal deficit should be initiated. At the same time, the quality of expenditure needs to be shifted from consumption, by reducing subsidies, towards investment.
(5) Implementing the Fourteenth Finance Commission’s recommendations will lead to states accounting for a large share of total tax revenue. This has the important implication that, going forward, India’s public finances must be viewed at the consolidated level and not just at the level of the central government. If recent trends in state-level fiscal management continue, the fiscal position at the consolidated level will be on a sustainable path.
Subsidies and the JAM Number Trinity Solution
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(1) The JAM Number Trinity – Jan Dhan Yojana, Aadhaar, Mobile – can enable the State to transfer financial resources to the poor in a progressive manner without leakages and with minimal distorting effects.
The Investment Challenge
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(1) The stock of stalled projects stands at about 7 percent of GDP, accounted for mostly by the private sector. Manufacturing and infrastructure account for most of the stalled projects. Changed market conditions and impeded regulatory clearances are the prominent reasons for stalling in private and public sectors, respectively.
(2) This has weakened the balance sheets of the corporate sector and public sector banks, which in turn is constraining future private investment, completing a vicious circle.
(3) Despite high rates of stalling, and weak balance sheets, the stock market valuations of companies with stalled projects are quite robust,which is a puzzle.
The Banking Challenge
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(1) The Indian banking balance sheet is suffering from ‘double financial repression’. On the liabilities side, high inflation lowered real rates of return on deposits. On the assets side, statutory liquidity ratio (SLR) and priority sector lending (PSL) requirements have depressed returns to bank assets.
(2) Private sector banks did not partake in the biggest private-sector-fuelled growth episode in Indian history during 2005-2012. This is reflected in the near-constant share of private sector banks in deposits and advances in those years.
(3) There is substantial variation in the performance of the public sector banks, so that they should not be perceived as a homogenous block while formulating policy.
Putting Public Investment on Track – the Rail Route to Higher Growth
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(1) The Indian Railways over the years have been on a ‘route to nowhere’ characterized by under-investment resulting in lack of capacity addition and network congestion; neglect of commercial objectives; poor service provision; and consequent financial weakness. These have cumulated to below-potential contribution to economic growth.
(2) Very modest hikes in passenger tariffs and cross-subsidisation of passenger services from freight operations over the years have meant that Indian (PPP-adjusted) freight rates remain among the highest in the world, with the railways ceding significant share in freight traffic to roads (that is typically more costly and energy inefficient).
(3) As a result, the competitiveness of Indian industry has been undermined. Calculations reveal that China carries about thrice as much coal freight per hour vis-à-vis India. Coal is transported in India at more than twice the cost vis-à-vis China, and it takes 1.3 times longer to do so.
(4) Econometric evidence suggests that the railways public investment multiplier (the effect of a Rs. 1 increase in public investment in the railways on overall output) is around 5. In the long run, the railways must be commercially viable and public support must be linked to railway reforms: adoption of commercial practices; tariff rationalization; and technology overhaul.
Skill India to Complement Make in India
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(1) What should we ‘Make in India’? Sectors that are capable of facilitating structural transformation in an emerging economy must:
- have a high level of productivity,
- show convergence to the technological frontier over time,
- draw in resources from the rest of the economy to spread the fruits of growth,
- be aligned with the economy’s comparative advantage; and
- be tradeable.
(3) India could bolster the Make in India’’initiative, which requires improving infrastructure and reforming labor and land laws by complementing it with the ‘Skilling India’ initiative. This would enable a larger section of the population to benefit from the structural transformation that such sectors will facilitate.
A National Market for Agricultural Commodities
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(1) Markets in agricultural products are regulated under the Agricultural Produce Market Committee (APMC) Act enacted by State Governments. India has not one, not 29, but thousands of agricultural markets. APMCs levy multiple fees of substantial magnitude, that are non-transparent, and hence a source of political power.
(2) The Model APMC Act, 2003 could benefit from drawing upon the ‘Karnataka Model’ that has successfully introduced an integrated single licensing system. The key here is to remove the barriers that militate against the creation of choice for farmers and against the creation of marketing infrastructure by the private sector.
Climate Change
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(1) India has cut subsidies and increased taxes on fossil fuels (petrol and diesel along with a coal cess) turning a carbon subsidy regime into one of carbon taxation. The implicit carbon tax is US$ 140 for petrol and US$64 for diesel.
(2) In light of the recent falling global coal prices and the large health costs associated with coal, there may be room for further rationalization of coal pricing. The impact of any such changes on affordable energy for the poor must be taken into account.
(3) On the whole, the move to substantial carbon taxation combined with India’s ambitious solar power program suggests that India can make substantial contributions to the forthcoming Paris negotiations on climate change.
The Fourteenth Finance Commission
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(1) The FFC marks a watershed in the history of Indian federalism. Unprecedented increases in tax devolution will confer more fiscal autonomy on the states. This will be enhanced by the FFC-induced imperative of having to reduce the scale of other central transfers to the states. In other words, states will now have greater autonomy both on the revenue and expenditure fronts. All states stand to gain from extra resources although there will be some variation between the states.
(2) FFC transfers are highly progressive; that is, states with lower per capita Net State Domestic Product (NSDP) receive on average much larger transfers per capita. In contrast, plan transfers were much less progressive. The concern that more transfers will undermine fiscal discipline is not warranted because states as a whole have been more prudent than the centre in recent years.
Courtsey: Hirish Sir, IAS
