Opinion | Economists must share some blame for the current slowdown4 min read . Updated: 19 Nov 2019, 10:45 PM IST
The reforms they now criticize were hailed by them as the next best thing after sliced bread
With 20/20 hindsight, it is possible to trace the origins of the current slowdown to fiscal 2016-17. While external factors may have contributed to it, there is no gainsaying the fact that the major contributory factors are domestic. This does not mean our policies were all wrong, just that the consequences of the multiple disruptions packed into that year are yet to play out fully.
The major disruptions that year were demonetization, the two mandates given to the Reserve Bank of India (RBI)—inflation-targeting and clean-up of bank balance-sheets—and the enactment of the Insolvency and Bankruptcy Code (IBC) as well as the 101st constitution amendment of 2016 that enabled the goods and services tax (GST) to be levied from 1 July 2017.
Critics will latch on to demonetization, whose third anniversary was noted earlier this month, as the key villain in this piece, and they would be right. But it would be foolish to pretend that the other reforms everybody applauded were not big contributory factors to the slowdown. On the other hand, the current consensus among economists is that only one of the planned disruptions has worked well—the RBI mandate to target 4% retail inflation over the 2016-21 period. Many suggest that GST isn’t working as its design is flawed, and the IBC has not delivered fast-track resolutions of bad loans, as originally envisaged.
While the government gets its fair share of blame for the disruptions that contributed to the slowdown, it would be wrong to let off economists and experts lightly. The reason: they tend to suggest reforms on the assumption of ideal conditions, which is almost never the case in a country as politically diverse as India, where the legal system is not known for quick delivery, and where large parts of the economy operate outside the formal sector.
Chances are that many economists are wrong even now. Inflation-targeting seems a success because of factors un-related to the pact between RBI and the government. It is the collapse of food and fuel inflation that has kept retail inflation in check. On the other hand, the Monetary Policy Committee’s focus on non-existent inflation kept real interest rates very high for a long time, turning a bad situation worse.
The IBC is fighting valiantly to avoid a painful slide into irrelevance—like its predecessors, the Sick Industrial Companies (Special Provisions) Act of 1985, and the Recovery of Debt Due to Banks and Financial Institutions (RDDB) Act—through frequent changes to its rules and requirements. The IBC is not a badly drafted law, but it is up against a crony banking-cum-legal system that frustrates most well-intentioned legislation. That an Essar Steel took nearly three years to resolve tells us why no law, however well-crafted, can be a silver bullet. In India, laws work well only after repeated trial-and-error.
As for GST, which has been the butt of criticism by political parties, economists and businesses, one wonders why only the government should take all the flak, when economists and businessmen were talking of this tax as the next best thing since sliced bread before it was adopted. The fact is that no economist worth his salt said that GST should never be implemented unless ideal conditions were created. The talk before it was launched was about achieving “revenue neutrality". Politicians bought into the idea as they were told that GST would raise gross domestic product growth by up to two percentage points annually. In hindsight, anyone can say that this should have been done differently, but this was not the song we heard from critics before July 2017. Even if some did warn of problems, the Narendra Modi government was right to ignore them since we could not have known where problems would arise without going ahead with it. Just as you can’t learn to swim by attending a classroom session, you can’t test IBC or GST without implementing it. In a complex adaptive system like the real economy, with multiple players and stakeholders pursuing different agendas, you cannot understand what will work and what won’t without actually plunging into the water. The other alternative is not to attempt any bold reform at all.
The short point is this: both the IBC and GST can be made to work through continuous feedback and agile responses to problems. In fact, it is the inflation-targeting exercise—the one easiest to implement—that is unlikely to work in the Indian context. Consider the current context. Retail inflation is well above 4% and wholesale inflation near zero. Should RBI now start tightening money because retail inflation is rising, or let things be since wholesale inflation and GDP growth are crashing? Given the continuing signs of rural distress, does it make sense to let food prices rise or fall? Should we target a headline inflation number at a time when higher inflation may be exactly what farmers need and businesses might get a leg-up from an associated recovery of pricing power?
Economists have much to be modest about, given that the things they are so critical of (GST and the IBC design) may actually deliver a bigger bang for the buck once their bugs are fixed, and the one thing they are applauding—RBI’s inflation-targeting—may yet fail.
*R. Jagannathan is editorial director, ‘Swarajya’ magazine