The Indian economy is facing a slowdown, with GDP growth clocking 5.8 per cent in Q4 2018-19 and 6.8 per cent for the year as a whole. This quarterly growth rate number, it may be noted, is being witnessed after a long period of about 18 quarters. Besides, during 2018-19, the quarterly growth rates have been consistently decelerating: 8 per cent in Q1, 7 per cent in Q2, and 6.6 per cent in Q3. It may also be noted that the slowdown is accompanied by a high unemployment rate across the labour force — skilled, semi-skilled and unskilled.

Together, they paint a gloomy picture of the economy and pose a tough challenge to the new government. There are reports of big bang reforms on the way but navigating these times is not going to be easy.

First, it is important to understand the nature of the slowdown that has taken root. The major contributing factors for the slowdown from the demand side are a deceleration in investment rate measured in terms of the percentage share of gross fixed capital formation (GFCF) to GDP in Q4 to 30.7 per cent from 32.8 per cent in Q1.

When analysed from the supply or economic activity side, technically called gross value added (GVA), the economic growth slowdown was primarily attributed to collapse of agriculture growth in Q4 to a negative 0.1 per cent from 5.1 per cent in Q1. Besides, there has been consistent deceleration in agriculture and allied sectors in all the quarters (Q2: 4.9 per cent, Q3: 2.8 per cent), which has resulted in a lower year-on-year (y-o-y) increase of 2.9 per cent than that of 5 per cent in 2017-18.

We must ask if the slowdown is statistical (because of the base effect), cyclical, structural, or a combination of these? In any statistical measurement, the base effect cannot be ignored, implying that a higher growth recorded in the previous year may result in a lower growth in the following year. But consistent lower growth on a quarterly basis cannot be ignored as temporary and cyclical. Moving the economic growth to a higher trajectory from below 7 per cent (6.8 per cent) in 2018-19 and 7.2 per cent in 2016-17 will be a challenge for the new government.

The RBI, in its Monetary Policy Report of April, has forecast that the Indian economy would grow at 7.2 per cent in 2019-20 and 7.4 per cent in 2020-21. This baseline scenario assumes a normal monsoon, benign CPI inflation and no oil shock. But the situation has reversed. As against 7 per cent growth projected by the RBI, the growth rate was 6.8 per cent in 2018-19.

Monsoon factor

The assumption of a normal and timely monsoon may not hold as the IMD has already predicted a delayed monsoon. Evidence suggests a delayed monsoon results in a below normal monsoon. In the event of such a situation, there will be pressure on agriculture in general and prices of vegetables and fruits in particular.

This development will result in a U- turn in the benign food inflation situation and lead to an upswing on the inflation front. If there is a reversal in inflation, growth will be adversely affected.

Besides, the geo political tension in trade relations with the US coupled with the possibility of oil price hike will swell the current account deficit (CAD) from the present estimate of 2.3 per cent GDP. This will put pressure on the exchange rate and make the management of capital flows and financing of the CAD in a non-disruptive manner difficult.

Thus, logging a growth rate of 7.4 per cent and moving the economy to its potential 7.5-8 per cent level will be a bigger challenge for the NDA government in its second term. The government, therefore, needs to make bold structural reforms, engaging itself with supply-side management. The conventional demand management of lowering interest rate through policy repo rate reduction is only a second-best solution at the current juncture.

One way to address the supply-side management is to look at the ratio of investment and incremental capital output ratio (ICOR). The investment rate needs to be supplemented by greenfield foreign direct investment (FDI). In this context, it is important to revisit the sectoral caps. So far as the domestic savings rate is concerned, there is an urgent need to reverse the dis-savings of the government by eliminating the revenue deficit, which was 2.3 per cent in 2018-19. This requires appropriate structural tax reforms by widening the tax base and increasing voluntary tax compliance — a long-term game.

Further, the government needs to urgently look at creating or enabling new employment opportunities. This ties into investments in physical and social infrastructure and increasing efficiency through higher productivity. ICOR on an average has been four (indicating four units of capital required to achieve one unit of economic growth) while the global benchmark is around two. Any reduction in ICOR critically hinges on increasing productivity.

PSU divestment

There is no quick fix in the given situation. Suggestions that the government will go on a PSU-privatisaton spree, as reported, carry little meaning because in the end who will buy PSU shares when the economy is weak and businesses are not reporting good numbers.

This is precisely what has happened in the past — PSU sales became inter-governmental adjustments, with public sector banks and institutions buying shares when the market does not. Thus privatisation cannot be forced or rushed — it must await its time, and can only be a slow process.

In general, supply management in terms of enhancement of productivity holds the key to higher growth and employment. Bold policy decisions on land reforms, labour market reforms, tax reforms for voluntary compliance, skill development through vocational training, strengthening of physical and social infrastructure, and autonomy for key institutions should be the focus of the new government. Some of these are in the works, but with the weather gods not smiling (at least for now) many a plan could go haywire.

The writer is a former central banker and a faculty member at SPJIMR. Views are personal. (Through The Billion Press)

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