Departures from fiscal targets can be justified, but only for very good reasons. They can also be condoned if stronger than expected action is taken on those reforms that markets believe will increase productivity in future
With three days left for the New Year, this column reflects on the past 12 months and looks ahead. Here are my personal takeaways.
2017 was a forgettable year
This has clearly been a disappointing year for GDP growth. In February 2017, the Economic Survey had projected that growth in gross value added (GVA) in 2017-18 would range between 6.75% and 7.5%. That was when the Central Statistics Office (CSO) had estimated growth for the previous year at 7.1%, which has since been revised to 6.6%. We will definitely undershoot the range.
The first quarter growth in 2017-18 was disappointingly low at 5.6%. There was a welcome upturn to 6.1% in Q2. I expect the recovery to continue, but official estimates overstate it. The Reserve Bank of India (RBI), for example, was surprisingly over-optimistic, earlier this month, when it projected 6.7% growth for 2017-18. This implies a massive acceleration in Q3 and Q4 which is not borne out by available data. My bet is that growth for 2017-18 (as a whole) will range between 6.2% and 6.4%.
The economy will definitely do better in 2018-19. The disruptive effects of the goods and services tax (GST) will be behind us, and some positive effects may start to show. Much will depend on whether private investment, which has been falling as a percentage of GDP, starts recovering. There is no indication of this as yet, but things could change. The International Monetary Fund (IMF) had projected 7.4% growth for 2018-19 based on the CSO’s earlier estimates of GDP growth. When the IMF updates its projections to reflect the downward revision in the latest CSO data, its projection for 2018-19 could fall to 7.2%, which is what the UN has projected.
Assuming 6.3% for 2017-18 and 7.3% for 2018-19, the average growth in five years of National Democratic Alliance (NDA) rule may just about equal the 7.1% performance of the much maligned United Progressive Alliance (UPA) II, and much below the 8.4% achieved in UPA-I. Cruising along at 7%-plus may look good, compared to what is happening in other countries, but is it good enough?
Where are the jobs?
The “feel good factor" for ordinary people depends not so much on growth as on whether inflation is under control, and whether they can find jobs. Inflation is not a problem right now, but jobs are.
The Labour Bureau’s annual surveys show that between 2013-14 and 2015-16, the absolute number of jobs has actually declined! Jobs in the primary sector (agriculture and mining ) declined by 8.46 million, which is to be expected since we expect a withdrawal of labour from agriculture. The problem is that jobs in the secondary sector (manufacturing, electricity generation and construction) have also declined by 2.81 million. Services sector employment did expand, creating 6.65 million additional jobs, but that was not enough to absorb the decline of 11.27 million in the other sectors.
All this suggests that (a) we need to get growth back to 8%-plus as soon as possible and (b) we need to work on how growth can generate more employment. Manufacturing is the traditional route for generating low- to middle-skill jobs suitable for labour shifting out of agriculture. However, managers in large manufacturing units warn that the pressure to improve quality and increase competitiveness is forcing rapid mechanization, and higher employment from modern manufacturing may, therefore, be unrealistic.
These pressures exist even in traditional labour-intensive areas such as garments, shoes, simpler consumer goods, etc. Within each sector, we should expect a shift away from very small, highly labour-intensive, informal-sector firms, towards mid-size firms with more modern technology which are less labour-intensive. If total production is constrained by the domestic market, displacement of very small units by more modern units could lead to a fall in total employment. However, this can be offset if (a) higher and more inclusive growth leads to the rapid expansion of the domestic market and (b) we can penetrate export markets more aggressively.
It is sometimes said that we should not count on exports because the backlash against globalization is leading to protectionism . This is too pessimistic. The demand for these products in industrialized countries is met almost entirely from imports and we are unlikely to see any protectionist push to expand domestic production of these items. In any case, industrialized countries are not the only market: Demand in the relatively fast-growing Asian countries is also rising. Besides, China will vacate export space in these products as it moves into higher-end products. Bangladesh, Cambodia, Vietnam and the Philippines are all competing for this space. We have very low export shares in these products at present and we could do much better if we are willing to adopt policies that will enhance our competitiveness.
A policy wish list for the New Year
Here is my wish list of things we should do that will yield benefits in the relatively short term.
(i) Macroeconomic balance is a basic requirement, and failing on this front can lead to a crisis which can derail everything. It requires laying out a fiscal time path that is seen to be credible and sticking to it. The Union finance minister has set out a fiscal “glide path" and he will be watched carefully to see if he keeps to it. Departures from fiscal targets can be justified, but only for very good reasons. They can also be condoned if stronger than expected action is taken on those reforms that markets believe will increase productivity in future. Inevitably, this is often a battle of perception.
(ii) The best way the government can contribute to the competitiveness of Indian manufacturing is to provide good infrastructure. The investment needed in infrastructure is so large that if we try to do it through the public sector alone,relying on budgetary resources, it will create intolerable fiscal stress. Public investment in infrastructure must, therefore, be supplemented by public-private partnership (PPP) wherever possible. Clear targets could be set for the mix of public sector and PPP investments envisaged in each sector. The policies proposed to attract PPP in each sector should be stated clearly and designed to respond to investor concerns in this area.
(iii) We should consider passing a law that would govern PPP in infrastructure. This would provide much needed reassurance to private investors desirous of coming into infrastructure development. One of the provisions in the law could be the establishment of a special dispute resolution mechanism for PPPs.
(iv) Exchange rate policy should correct the real appreciation of the rupee by about 16% since 2013. Failure to do so has led to demands for higher import duties to protect domestic producers, which have been conceded in several cases. Raising import duties as part of anti-dumping action is justifiable, but resorting to a general increase is not. It helps domestic producers competing against imports but it does nothing for the competitiveness of exporters who are also affected by loss of competitiveness. The US Fed has raised the fed funds rate and there is an expectation that other central banks may follow suit. This is expected to lead to an outflow of capital from emerging markets in 2018. We should avoid fighting any outflow by using reserves, and let the exchange rate adjust instead.
(v) The GST is a very important reform, which has multi-party support, and is also widely appreciated internationally. There have been glitches in implementation, but the readiness to make changes to overcome problems that have arisen is a good thing, even if it attracts the criticism that the problems could have been avoided. The biggest problem is that there are too many rates, with too wide a spread. Some recent statements from the finance ministry suggest a willingness to move to fewer rates and narrow the spread. Putting this firmly on the agenda, even if after the 2019 election, would send a very good signal. Meanwhile, the pressure to introduce e-way bills and deny credit for earlier stage taxes unless they are actually paid by the supplier is illogical and should be resisted.
(vi) The Insolvency and Bankruptcy Code (IBC) promises real progress in getting indebted large corporate entities to pay up their debts or surrender control. If a dozen of the large debtor cases sent to the National Company Law Tribunal come to a successful conclusion in the course of 2018, we should count it as a success even if the resolution involves large haircuts for the banks.
(vii) Recapitalizing public sector banks (PSBs) is essential, but what has been promised will only help to fill the hole in the balance sheets of banks. It will not allow credit to expand at the rate needed to support 8% GDP growth. There is also no evidence yet of credible structural reforms that will change the way public sector banks (PSBs) function. Ideally, government equity in the banks should be lowered to under 50%, at least for some PSBs to start with. Banks should also become genuinely board-managed, with senior appointments made by the board and not the government. The role of the finance ministry as an additional regulator, in addition to the RBI, must end.
(viii) Successive governments have ducked the politically sensitive issue of amending the Industrial Disputes Act to allow retrenchment of the labour force. We must recognize that the present law actively discourages managements from hiring labour. Leaving changes in the law to the states is an improvement, but what has been done so far by some states is inadequate. It only raises the limit of employees for the Act to kick in from 100 to 300. If we want to increase employment, we need to extend flexibility to all firms, with suitable measures for protection of labour.
There are other important areas for policy action, notably in agriculture, health and education. They will have to be taken up in later columns.
Montek Singh Ahluwalia was the deputy chairman of the erstwhile Planning Commission.
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