Reviving growth: Need to tackle the macroeconomic imbalances

Reviving growth: Need to tackle the macroeconomic imbalances

Arun Kumar

Sukhamoy Chakravarty Chair Professor, CESP, SSS, JNU.

Published The Hindu, June 7, 2014.

BJP’s dramatic victory is partly a result of UPA’s failure to tackle Indian economy’s problems. Persisting high rate of inflation, declining growth, inadequate employment generation, fiscal deficit, current account deficit and corruption contributed to the public’s disenchantment with UPA. Expectations are high that the new government will tackle these problems decisively and bring relief to the public.

The economy’s rate of growth has declined quarter after quarter since the end of 2010-11, i.e., for the last 12 quarters. The industrial sector has been showing negative or near zero rates of growth recently. Services sector, the engine of growth for the economy, has experienced declining rates of growth and so has agriculture. In turn, this has led to sluggish employment generation. The problem has been compounded by the capital intensive nature of current investment which uses less labour and more capital, so that even when output rises, employment hardly grows. Most are forced to work in the informal sector at low wages which coupled with high persisting inflation causes economic distress and political unrest.

This state of affairs is due to the decline in the rate of investment from its peak of 38% in 2007-08 because of the global economic crisis. It went up in 2009-10 but is down to about 32%. It is still high compared to the figure of around 20-23% in the 1990s. It rapidly increased in the 2000s leading to the boom of 2003-2008. The rapid increase in investment was engineered by allowing national income to shift rapidly in favour of the high savers - those who have high property incomes. This was evident from the direct tax data which showed that corporate tax collections boomed after 1999. This trend has led to a rapid increase in inequality in society and a slow rise in mass consumption so that the growth of the economy has depended more and more on rising investment levels.

Hence the crucial determinant of growth in the economy in the period after 2000 has been investment. So, as the investment rate declined after 2010-11, the rate of growth of the economy fell. Investment in the economy depends on private investment, both foreign and domestic and on public investment. There has been a problem with each one of them.

The situation has been aggravated by developments on the external and the fiscal fronts. The green shoots in US did not bloom, Eurozone went into a double dip recession, Japan continued its sluggish growth and the Chinese and the other BRICS economies slowed down. Thus, exports growth rate has been low. But, imports rose sharply due to the high import bill for petro products and increase in gold import bill. The consequence has been a high trade deficit and current account deficit and a decline in demand in the economy. This has also been accompanied by reduced inflow of foreign investments so that the value of the rupee viz-a viz the dollar declined sharply in the last few years. This added to the imbalance on the external front with speculation and flight of capital aggravating it. The threat of a downgrade of the country by the credit rating agencies has been looming which could lead to an increase in cost of borrowing abroad and to a rise in the current account deficit.

Foreign investment has slowed down but it only constitutes around 10% of the total investment in the economy. Bulk of the investment is internal and this has slowed down due to several factors. One of them has been the unravelling of scams since 2009 and the intervention of the courts. This has impacted the confidence of the business community which was used to using crooked means to manage its investments and the markets. After the court interventions there have been question marks on many decisions like, allotment of spectrum and coal blocks and iron ore mining. This has unnerved businessmen who have lost the confidence that they can manage the business environment in the old way.

The confidence has also been shattered by the widespread public protest against large scale acquisition of land needed for major projects. This goes back to days even before Singur. Resistance has continued in Jaitapur, Koodankulam, POSCO, Tata Mundra and so on. Some of the big ticket investment projects have been called off, like, the $12 billion project by the Mittals. The problem remains unresolved because the public perceives a loot of natural resources – land, air, water, spectrum, forests and mines – at its expense. So, execution of big projects has slowed down. The private corporate sector has been flush with funds which they have not invested due to the uncertainty and sluggish demand in the economy. In brief, the slow down in internal investment is a result of the discredited model of investment in the county which has been based on collusion between the businessmen, politicians and the bureaucracy. Thus, for different reasons, both foreign and domestic private investment has slowed down.

The last element, public investment also slowed down because of policy paralysis in the government and even more importantly due to the sharp cut back in Plan size in each of the last 5 years so as to keep the fiscal deficit down; compared to the budget estimates the actual has been less by Rs.5 lakh crores in these five years. This has led to slow down in investment in infrastructure and aggravation of shortages.

Because of the slow down in the economy, tax revenue increase has suffered. That is why the fiscal deficit has tended to increase and to keep it in check, the Plan size has been curtailed. But that sets up a vicious negative cycle. As the economy slows down, threat of downgrade by the credit rating agencies increases, revenues of the government rise less and the deficit tends to rise both of which lead to a loss of confidence and a further slow down.

Can the new government tackle the difficult economic situation? Mr. Modi is reputed to be a `man of action’ but the issue is what action? The corporate sector has backed him in the hope that he would reverse the fortunes of industry. The stock markets have risen sharply in the last few weeks. Can the new government simultaneously fulfil the hopes of business and of the under employed youth hoping for a miracle?

While the rise in the stock markets signals the flow of funds from FII, it does not mean that FDI will suddenly increase. Further, there is the danger of a speculative bubble building up – as in the past - which could collapse and adversely impact the investment climate. This could be triggered by the continuing easing of the Fed intervention in the US – something that is ongoing. Even if foreign investment increases, it is a small part of the total investment so it cannot be the major stimulus needed. Domestic investment – public and private – needs to be revived. Large investment is going to remain hamstrung by environmental and other clearances and difficulties in acquisition of land unless laws are changed but that would take time. Transparency in business decisions is needed to revive investment and that also needs time. So, the only thing that can be done soon is to increase public investment and especially in rural areas where infrastructure is woefully inadequate.

Schools, dispensaries, roads, telecom, water, small irrigation and so on are needed urgently in rural India. This can potentially create lots of jobs unlike the big investments and would be much less expensive than in urban areas because land is less expensive. Thus, it would benefit many more people and slow down the expensive and environmentally damaging urbanization currently taking place. But this requires efficient governance.

In brief, the problems of the economy stem from the macroeconomic imbalances and corruption and unless they are addressed, the economy will not recover. The need today is not only for a decisive leader but for a new holistic macroeconomic approach – a break from UPA’s policies. Unfortunately, the BJP manifesto only presents a hint of its macro economic plan and that too towards the end of the manifesto, as if like an after thought. Hopefully, the Union budget will help clarify matters.

arunkumar1000@hotmail.com