“Achhe din aane wale hain," Modi promised. The Hindi sentence translates as: “The good days are on their way."
Having watched the Congress-led United Progressive Alliance, or UPA, lurch from one corruption scandal to another in its second term, and with economic growth faltering, the Indian electorate handed a landslide victory to Modi’s Bharatiya Janata Party (BJP); the party became the first in 30 years to win a majority on its own in the elected lower house.
Three years and four months on, it’s the Indian economy and the perceived failure to create a sufficient number of jobs that’s looming as the Achilles’ heel of the Modi government.
Sample this: Economic growth decelerated to a three-year low of 5.7% in the June quarter of 2017-18, from 6.1% in the preceding quarter.
The current account deficit (CAD) hit a four-year high in the same quarter at 2.4% of gross domestic product (GDP) despite benign oil prices that have cushioned government finances.
Congress vice-president Rahul Gandhi said on a visit to Princeton University in the US in September that his party had lost the 2014 election because it had failed to create jobs. And the Modi government had failed, too, on the jobs front, he said.
Official figures on employment generation aren’t available. According to the lobby group, the Confederation of Indian Industry (CII), the number of jobs created has lagged far behind the estimated one million people who are entering the workforce every month. Between 2011-12 and 2015-16, India created 3.65 million jobs a year, according to CII.
Black swan events
To be sure, two black swan events—high-impact occurrences that no one had foreseen—in the space of nine months contributed to the recent slowdown in economic growth.
In November, Prime Minister Modi banned Rs1,000 and Rs500 banknotes in what the government billed as a war against the shadow economy, terrorist financing and counterfeit currency notes.
This “demonetisation" move took out 86% of the currency in circulation by value and led to a cash crunch that took several weeks to ease, hurting many cash-dependent small businesses.
Then the government pushed through a goods and services tax (GST) law that laid the foundation for a new indirect tax regime with effect from 1 July 2017.
Temporary disruptions in the supply and production chains, and destocking and inventory liquidation by distributors and retailers were the consequences.
While investment demand was anyway weak when the NDA assumed office, private consumption has also started decelerating.
Output of capital goods—a proxy for investment demand in the economy—contracted 1% in July against growth of 8.8% a year ago.
Production of consumer durable goods shrank 1.3% against a nominal increase of 0.2% a year earlier. The domestic economic gloom, coupled with US-North Korea tensions and the Federal Reserve’s plan to start unwinding its balance sheet in October, has taken its toll on the stock market.
The Bombay Stock Exchange’s benchmark Sensex has so far gained 17.6%, but has shed 3.8% from its 2017 high; the rupee weakened 3.2% against the dollar from its high this year as foreign investors pulled out money. Since 1 August, foreign investors have net-sold nearly $2.51 billion of Indian stocks; their net purchases in 2017 amount to $6.4 billion now.
As news of the economy dominated the headlines, the government went into a huddle; on 20 September, finance minister Arun Jaitley said the government was working on a stimulus package to revive the economy.
“...the economy is slowing, the current account deficit has widened dramatically," said Andrew Holland, CEO at Avendus Capital Alternate Strategies Llp. “They (the government) are talking about stimulus, and let’s see how that shapes up."
And on 26 September, Modi revived the Prime Minister’s Economic Advisory Council, which had become defunct after the 2014 Lok Sabha election. Economist Bibek Debroy will head the five-member council, which will address macroeconomic concerns and take on any assignment Modi refers to it.
“The intention behind the advisory council is to help in reviving the economy since growth stagnation is a serious issue," said Madan Sabnavis, chief economist at CARE Ratings Ltd.
According to a Reuters report, which cited two officials with direct knowledge of the plan, the government is considering a plan to loosen its fiscal deficit target of 3.2% of GDP to enable it to spend up to Rs50,000 crore ($7.7 billion) more to halt the economic slowdown.
Globally, too, there is growing clamour for setting aside austerity measures and pushing for growth. The United Nations Conference on Trade and Development (UNCTAD) in its latest trade and development report, titled Beyond Austerity: Towards a Global New Deal, called for a globally coordinated strategy of expansion led by increased public expenditure to crowd in private investment.
UNCTAD said the Indian economy faces “serious downside risks" as the government’s demonetisation drive, GST and corporate deleveraging could accelerate the slowdown and make recovery difficult.
Pronab Sen, former chief statistician of India, who has worked in the government for the past 25 years, said the problem started with the reversal of rural growth, which remained high during the 2004-12 period, propelling overall economic growth.
“While farm output was growing at 3%, farm income was increasing by 7.5%. Income of the poorest was growing rapidly (and) that drove growth as well as inflation," he said.
The problem began in 2013-14 when things started to reverse. Global food prices came down while the Reserve Bank of India (RBI) still maintained a restrictive monetary policy. Growth in the minimum support price (MSP) of selected farm products slowed dramatically to 3.5% per year from an average of around 8% earlier.
After 2014, the government’s job guarantee plan, which assures 100 days of manual work a year to at least one member of every village household, became resource-driven rather than demand-driven.
Less focus on the programme, especially during the two consecutive drought years of 2014-15 and 2015-16, aggravated the rural demand situation and dampened rural growth. Then came the twin black swan events.
Demonetisation came as a body blow to the cash-dependent unorganized sector that makes up 40% of India’s GDP.
Anecdotal evidence showed that farmers were being forced to dump their produce for want of buyers and small businesses were laying off employees.
The implementation of GST forced companies to reduce production in the run-up to its 1 July implementation as dealers reduced inventory. Technical glitches in filing of GST returns and delays in refund of input tax credit for exporters further dampened business sentiment.
Sen says that if concerns surrounding the refund of input tax credit are not quickly resolved, there will be a huge spurt in demand for working capital by companies which banks, burdened by an estimated Rs10 trillion of stressed assets (including bad loans and restructured loans), won’t be able to handle.
“So far we have a demand-side problem. If a supply-side problem is added to it, it will further bring down our GDP for next two quarters," he said.
To be sure, bad loans are a legacy of the previous government.
The share of working capital loans in total lending has fallen from 76% in 2002 to 48% at present; lending for housing and fixed capital rose from 24% of total lending to 52% without a resolution mechanism such as the current insolvency and bankruptcy law in place.
Sen says such a law should have been in place seven-to-eight years ago and blames the United Progressive Alliance for the mess in the banking system. NPAs, or bad loans, in state-owned banks touched Rs6.41 trillion by 31 March 2017 from Rs1.56 trillion on 31 March 2013. This excludes restructured loans.
It will be an uphill task to come out of the economic trough at a time private investment as a driver of economic growth is missing and government spending has been the sole driving force for the economy.
CII has called for an interest rate cut of 100 basis points for boosting the economic growth rate. One basis point is one-hundredth of a percentage point.
It has also suggested interventions for depreciation of the exchange rate that would increase export-related jobs. A cut in interest rates would encourage domestic demand in sectors such as affordable housing, consumer durables and construction, it argued.
With the trend in inflation reversing (consumer price inflation accelerated in August for the second consecutive month to 3.36% from 2.36% a month ago), RBI is unlikely to be willing to cut interest rates.
Banks have also not passed on successive policy rate cuts by RBI, raising questions about the effectiveness of monetary policy in boosting growth.
“Monetary policy-based solutions are not going to work in such a situation as banks are not going to increase lending substantially in the current scenario. Only an aggressive fiscal push with a dedicated timeline can take the economy out of the current slowdown," Sen said.
“Think small, not big, and begin now," is the one-line prescription by Sen. “No bullet trains, no eight-lane highways. Focus on rural housing, rural roads, minor irrigation projects where results can be delivered quickly," he said.
The government may announce fiscally expansionary programmes without breaching the 3.2% (of GDP) fiscal deficit target for 2017-18, said D.K. Srivastava, chief policy adviser at EY India.
“Public and departmental enterprises that can spend on infrastructure may be asked to speed up and enhance their capex (capital expenditure) plans for the year. The central government may also co-opt some state governments to work towards this objective."
The government has already exhausted 92% of its full-year borrowing target in the first four months (April-July) of 2017-18 and may find it difficult to spend beyond its budgetary means this fiscal year, Srivastava added.
The government should push for a revival of stalled private projects and speed up public sector projects, said Ranen Banerjee, partner at PwC India.
“Reviving the stalled private projects will help in the picking up of economic activities and positively impact the balance sheets of public sector banks," Banerjee said.
Banerjee added that the government needs to address teething GST-related problems and should not let these impede growth.
“If economic growth does not pick up in the September quarter, the government may not have any option but to pump-prime the economy in the next budget. However, it should not send the signal of being fiscally profligate, lest the state governments start slipping from their fiscal discipline commitments," he added.
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N.R. Bhanumurthy, a professor at the think tank, the National Institute of Public Finance and Policy (NIPFP), said a slowing economy may warrant the counter-cyclical measure of fiscal expansion even at the risk of a marginal slip from the fiscal consolidation plan.
“Recapitalization of state-owned banks is one way of doing it, which will also help banks while improving access to credit in the economy. Stepping up capital expenditure by public sector is another," he said.
According to former chief statistician Sen, to boost spending on infrastructure, the fiscal deficit can be allowed to slip to 3.5% of GDP from the 3.2% budgeted for 2017-18 and then to 4% of GDP for the next two years after which it can be gradually brought down.
“In a crisis scenario like the present one, homeopathic solutions will not work. The economy needs steroids," Sen said.