Focusing on domestic growth

Given the demonetisation undertaken by the government in November 2016, the current budget was presented at a historic moment in the Indian economy. To understand the government’s emphasis on the rural economy, we have to understand a key narrative that must influence economic policies in democratic countries.

As several governments in developed countries become more protectionist, the export-driven growth models followed by China in manufacturing and India in IT and IT-enabled services will produce diminishing returns. Unlike the smaller economies such as those of the East Asian nations, a large economy such as ours can shift away from export-oriented growth to domestic-consumption-based growth. However, for this to happen, rural demand and demand among the poorer sections of society has to be increased significantly. This can only happen if productive jobs and productive enterprise increase significantly for the poorer sections of society and thereby enhance disposable income among the domestic population. This will need “Make in India” to combine with “Make for India”, “Skill India” to combine with “Work gainfully in India” and “Startup India” to combine with “Feed, clothe, house and serve India”.

Given the current levels of inequality, such a boost in domestic consumption cannot happen in the immediate future. India not only has one of the highest levels of inequality in the region, it also shows very large increases in inequality since 1990. Its net Gini index of inequality (based on income net of taxes and transfers) rose from 45.18 in 1990 to 51.36 in 2013. Thanks to the high growth achieved since liberalization, India has made great strides in reducing poverty. While 80% of the rural population was poor in 1990, this percentage was less than 30% in 2011. Also, while about 40% of the urban population was poor in 1990, this percentage was less than 20% in 2011. Yet, these impressive figures look discouraging when compared to even Vietnam and Indonesia, which all started with higher poverty levels than India in 1990 and have been able to do better than India in reducing poverty. A more equitable distribution in the gains from growth is required to boost the consumption capacity of the Indian economy.

One of the key trends underlying this huge concentration of wealth and incomes is the increasing return to capital versus labour. In almost all rich countries and in most developing countries, the share of national income going to workers has been falling. This means workers are capturing less and less of the gains from growth. In contrast, the owners of capital have seen their capital consistently grow through interest payments, dividends, or retained profits faster than the rate at which the economy has been growing. Tax avoidance by the owners of capital has only served to exacerbate this cleavage between the returns to capital and to labour. To balance the disparity in the returns to capital versus the returns to labour, creating jobs in the economy is absolutely paramount.

Given these emerging trends in the medium to long term, the current government’s emphasis on reducing risks in the poorer and weaker sections of society through the twin tools of large-scale insurance programmes and credit availability is important. Economic shocks affect the poor significantly more than the rich or the middle classes. The ability to bounce back from economic shocks is important if the overall economic status of the poor has to improve. This year’s budget further pushes this agenda by proposing to raise coverage under the Pradhan Mantri Fasal Bima Yojana scheme to 40% in FY18 and 50% in FY19. So far the progress on this front is encouraging, with 39 million hectares or 26.5% of all farmers covered as of December 2016. The target for agriculture and allied credit has been set at Rs10 trillion, which is quite substantial. The allocation to the Pradhan Mantri Krishi Sinchayee Yojana is up 71% when compared with the FY17 estimate. The doubling of the total corpus of the National Bank for Agriculture and Rural Development’s (Nabard) Long-Term Irrigation Fund and a new micro-irrigation fund are also important steps in this direction.

Also important is the increased allocation for construction activities such as roads and affordable housing. Both are highly labour-intensive and employ low-skill workers. Affordable housing under the Pradhan Mantri Awas Yojana has received an increased allocation of 38.7% over FY17. Allocation for road transport has increased 11% in fiscal 2018. In the same spirit, the 44% increase in allocation to rural housing will also help push job creation and create demand in the rural economy. Providing infrastructure status to affordable housing will facilitate higher investments in this sector and, thereby, create low-skilled jobs. The income-tax exemption for developers of affordable housing with a carpet area of 30 and 60 sq. m in the four metros and non-metros, respectively, instead of built-up area of 30 and 60 sq. m will bring a larger number of projects under the ambit and, thereby, foster higher investments in this sector.

Given the emphasis on outcome-based monitoring advocated by the government, the outcomes in these key areas of rural development must be carefully monitored to ensure success of the initiatives. Such success would pave the way for the economy to substitute away from the focus on export-oriented growth to domestic-consumption-based growth.

Krishnamurthy Subramanian is associate professor of finance at the Indian School of Business and a board member at Bandhan Bank and the National Institute of Bank Management.