Opinion

Economy in need of ‘ICU’ treatment

Vidya Mahambare | Updated on March 09, 2018

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Industry needs the right Incentives, accompanied by Credibility and Urgency in policymaking



India’s current economic woes render it critically ill and in need of intensive care. Its economic growth almost halved in just two years — from nearly 9 per cent in 2010-11 to 4.5 per cent last year. In 2013-14, as both industrial and services growth weakened further, while agriculture saved the day by putting up a positive performance.

There has been much discussion and debate in the public domain on persisting troubles in the economy — from a revival of mining and manufacturing to re-igniting consumption. All these can be summed up as a kind of ‘ICU’ the economy needs for a turnaround — one where Incentives, Credibility and Urgency drive both policy and implementation. The government that comes to power after May 16 will have to focus on each of these.

Incentives

Currently, the incentive system — for producers and consumers alike — has weakened. Private businesses have little incentive to invest more, as their capital is yielding low returns, and households are not motivated to spend as they do not feel assured of higher incomes in the future. Also, the lower return on investments in financial assets has resulted in a greater proportion of household savings going into real-estate and gold.

What’s more, with fewer jobs available and no signs of a pick-up in job creation, the young hardly have an incentive to invest in quality education and skills. All these point to the need to improve the incentives.

Take the cut in excise duties announced in the interim Budget. Will the lower prices of consumer durables and vehicles — resulting from the duty reduction — motivate consumers to buy more? It did work during the downturn in 2008 and 2009 — sales of automobiles, for example, jumped significantly then. The same incentive, however, cannot work today.

That is because something else also played a major role in demand revival back then — incomes of many households, both rural and urban, had shot up sharply during those years. Among other things, fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission recommendations had led to organised sector salaries jumping 20 per cent. This sizable jump, perceived as an increase in permanent incomes, coupled with the lower prices of durables and vehicles, prompted consumers to buy more.

That critical incentive is missing this time around. Indeed, people who benefit the most will be those who had already decided to buy a vehicle; the government will lose out on the tax it would have collected. How can one persuade households to spend more? This can happen only if incomes begin to rise, more jobs are created and economic certainty returns. To begin with, the government must improve incentives to produce in sectors where supply is already in deficit and /or sectors that are employment-intensive — mainly infrastructure areas such as roads and power.

Credibility

Merely announcing incentives, however, will not generate the intended response. The policy measures must be Credible, inspiring in the stakeholders the confidence that they will be carried out. Returns on infrastructure projects are determined by overall project costs. To paint an ideal scenario, the tax regime should be stable, acquisition of land should be easy, wages should be in line with productivity levels, and there should be minimum deterrents to completing the project on time. Finally, interest rates should be predictable.

If the central bank announces a policy that requires to it to take a tougher stance on inflation, it must act in a manner consistent with this. This will change people’s expectations about future inflation as well as interest rates, and influence their decisions on consumption and investments.

Urgency

So we need to improve credible incentives in the economy, and soon. That requires a sense of Urgency — of the kind we saw last year when rising imports, especially of gold, threatened the rupee’s stability. These measures, however, may not provide lasting comfort unless the outlook for the real sector improves and attracts sustainable foreign capital. What will the new government do?

The writer is Principal Economist, Crisil

Published on May 07, 2014

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