What should be done for our economy to chart a recovery4 min read . Updated: 06 Sep 2020, 07:16 PM IST
Increase public spending to stimulate demand and push for efficiency-enhancing reforms to raise post-covid growth prospects
Official acceptance that India’s gross domestic product (GDP) fell by 24% in the first quarter of 2020-21 opens the door for some rethinking. Until recently, government spokesmen were speaking of “green shoots" and a possible V-shaped recovery. We now know better. The 24% decline makes India the worst performer of all major economies. This has implications for both short- and long-term policy.
First, the short term. Most analysts now predict that GDP for the year will fall by 7-11%. This raises the question, can we tweak policy to do better?
Although the lifting of the lockdown allows production to resume, it will recover only once demand picks up. Demand will recover as production expands and income begins to get generated. However, this will take time and even after incomes revive, consumers will likely defer spending on non-essentials until they are more confident about the future. Investment demand has also collapsed, and with many companies in financial stress, an early recovery is unlikely. And to cap it all, exports have not been doing well.
The government recognized that a stimulus was needed and the ₹20 trillion package was presented as a response. It was massive on the face of it (10% of GDP), but most of it consisted of credit expansion and restructuring of loans. This helps keep businesses afloat until demand recovers, but it does not directly stimulate demand. For that, we have to look at the expenditure component of the package, and this part was relatively small.
The likelihood of a large contraction makes a strong case for increasing expenditure in the rest of the year on: a) programmes that support the poorest groups, which have suffered the most, and, b) accelerating ongoing public investment projects in infrastructure. Increasing expenditure at a time when tax revenues will be much lower than targeted because of the fall in GDP will be a double whammy on the fiscal deficit. Fiscal conservatives will worry about possible adverse reactions from rating agencies. This is certainly a relevant consideration, but it is possible to explain the rationale of the approach to rating agencies, especially since other major countries are doing the same.
Tax revenues are likely to fall short by about 2.5% of GDP, but it makes no sense to respond by cutting expenditures to preserve the fiscal deficit. A slippage in the deficit should be accepted on this count. In addition, increased government expenditure will raise the deficit further. Critics will say that India does not have fiscal space since the deficit and public debt-to-GDP ratio are much higher than in most developing countries. However, that only means the higher fiscal deficit necessitated by short-term compulsions in the current year must be followed by bolder steps to achieve fiscal consolidation once normalcy is restored. A credible plan for consolidation in the next five years is what is needed. This has to be part of the longer term agenda, to which I now turn.
Looking ahead, we have to consider what our growth prospects will be in the post-covid period. The contraction in the current year will be followed by a recovery in the next fiscal year. But even if the economy expands by 7% in 2021-22 after contracting by 7% in 2020-21, this does not mean continuing growth at 7% thereafter. The real problem is that India’s growth had slowed down before the covid pandemic and was only 4.2% in 2019-20. We need to work out why this slowdown occurred and what is needed to reverse it.
The McKinsey Global Institute (MGI), in a recent study, has argued that India needs to grow at 8-8.5% from 2022-23 onwards if we are to create the non-agricultural jobs we need to meet the aspirations of our young labour force. We did grow at that rate for seven years between 2004-05 and 2010-11, but that was a long time ago. Can that growth momentum be revived? The MGI report says it can, provided we implement a number of reforms that would increase productivity and efficiency and also increase investment, both domestic and foreign.
The list of reforms is familiar. They include increasing the role of the country’s private sector in improving agricultural marketing, making it easier for industrial and housing projects to acquire land, offering surplus land with the public sector to overcome land constraints, introducing greater flexibility in the labour market, privatizing banks as well as reducing the government’s role in controlling public sector banks, privatizing electricity distribution to reap efficiency gains, eliminating the cross subsidies in electricity tariffs that make electricity more expensive for industry than for residential consumers, encouraging an open trade environment with low tariffs and eliminating tariff inversion, increasing the floor space index in cities to allow expansion in housing and urban development, amending rent laws to encourage private supply of rented housing, and expanding public expenditure to build infrastructure of various types.
Many of the reforms are controversial and will attract criticism for being pro-private sector and pro-market. But, the alternative, according to MGI, is to reconcile to tepid growth of 5% or so.
The reforms fall into three groups: about 40% can be done by the central government alone, another 40% require action by both the Centre and states, and 20% can be done by the states alone. Getting agreement across the Centre and states is not easy, but perhaps the central government should outline a time-bound plan of action on what it proposes to do, invite suggestions on how it is best done, and then do it.
We can then leave it to competition to nudge states to do their bit, especially if early adapters see benefits. Competitive federalism could lead to cooperative federalism.
Montek S. Ahluwalia is an economist and former deputy chairman of the Planning Commission of India