Charting the near-term policy road map
The monetary policy committee of the Reserve Bank of India (RBI) surprised the market by holding rates and changing the policy stance from accommodative to neutral to give itself more flexibility. The market was expecting a 25 basis point cut in policy rates. However, since the banks have reduced lending rates significantly in the wake of the currency swap initiative and influx of liquidity, a rate cut at this stage would not have made much of a difference.
At a broader level, now that the two big events—monetary policy and Union budget—are out of the way and there is a fair amount of clarity in terms of policy direction, it’s time to shift the focus back on implementation and some of the impending policy challenges. In this context, there are five broad areas that will be worth tracking in the near term or in the coming quarters.
First, in the budget, finance minister Arun Jaitley announced that the government’s capital expenditure would go up by over 25% in the next fiscal. This is a welcome move. As private investment continues to remain weak, the government’s capital expenditure will help in maintaining the growth momentum. However, government’s capital expenditure may not be sufficient to push growth in the medium to long run. One of the reasons for weak private-sector investment is the stressed banking sector balance sheet and the reluctance of the banking system to lend to the corporate sector. The budget has provided Rs10,000 crore for recapitalization of public-sector banks, which will not be sufficient. Apart from 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.
Second, one of the biggest challenges in the next financial year will be the implementation of the goods and services tax (GST). 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.
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Third, it is now becoming clear that the impact of the currency swap on economic activity is likely to be temporary and the government will now have to focus on gains. Since the government has gathered an enormous amount of data on deposits, it would do well to quickly gauge the possible fiscal benefit. There are suggestions that the gains should be distributed among Jan Dhan account holders. The government should avoid such ideas. Distributing money might result in short-term political gain for the ruling party, but it will set a bad precedent. The gains should be used to push capital expenditure—including in rural areas—which will help augment growth in the medium to long run.
Fourth, one of the biggest disappointments in the budget was that even though the government decided to cut the tax rate for smaller companies, it did not 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.
Fifth, now that India’s macro fundamentals are a lot more stable than they were a few years ago, the government can now concentrate on structural reforms. Jaitley in his budget speech said that legislative reforms will be undertaken to simplify rules in the labour market. Simplification of labour laws will help reduce the compliance burden and will be a big positive, especially for the manufacturing sector. Simultaneously, 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.
Policy movement in these areas will be critical in maintaining growth momentum and building a foundation for higher sustainable growth in the medium to long run.
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