India at 70: Avoiding traps

As India completes 70 years as a nation, there have been a spate of analyses over the past and the future. Successes are many but if there is one cause of our developmental failures, it is uncritically grafting external thinking. This early trapped us on a state-led non-development path.

The liberalising reforms have been a long struggle to escape its consequences. They brought in the advantages of more openness, competition and diversity. But there are signs that very conservative market-led thinking may be trapping us again on a slow growth path. The latest quarterly rate of growth has fallen to 5.7 per cent.

Such thinking asks for all kinds of reforms as a precondition for any macroeconomic demand stimulus. But waiting for the best to be achieved smothers the possible. A World Bank study on 13 developing economies that achieved above 7 per cent rates of growth for more than 25 years found their policies to be pragmatic rather than ideological.

Indian monetary-fiscal stimulus, justified as part of global coordinated action after the Western financial crisis of 2008, did raise growth sharply, but inflation remained high. It is therefore argued that a demand stimulus today would raise inflation again.

But there are differences between 2008 and 2017. First, inflation, especially food inflation was already high in 2008, and was pushing up wages. Much of the fiscal stimulus went to rural construction, which gave a further boost to food demand and to rural wages, generating a wage-price push. The growth boost was regarded, rightly, as consumption-led and therefore unsustainable. It fizzled out in 2011 as the macroeconomic stimulus was reversed, and the euro debt crisis decimated exports.

A fiscal stimulus in 2017, however, is likely to have very different effects, even as softer commodity prices anchor inflationary expectations. First, the farm loan waiver will probably reduce rural demand, since it forgives past loans but reduces expected future loans and therefore consumption. Research shows that rural households reduce spending after a farm loan waiver. Food dominates in the consumption basket of agricultural labourers, but the middle class spends more on fast moving and durable consumer goods, where there is excess capacity. Since the pay commission award will go more to the middle classes it should raise output, not prices.

When supply conditions are not adverse, output increases more from fiscal expenditure. It is true government investment expenditure multiplies output much more than consumption expenditure does, since it improves the supply-side as well as raises demand. But in conditions of excess capacity, as consumption uses capacity it will induce investment, so revenue expenditure can also have a multiplier effect. There will not be much of an aggregate fiscal stimulus, however, since the overall legislated cap on Central and State deficits will continue. There will only be a shift towards revenue expenditure. However, to the extent that innovative non-budgetary financial instruments are used more effectively and public sector undertakings invest, the fall in public investment would be moderated. Complimentary private investment and asset restructuring could add to this impact.

Among current drags on growth is the slow rate of growth of credit. Many fin tech startups are using newly available data from digitalisation of payments and GST to quickly assess their credit risk and lend to small enterprises. But the corporate bond market and equity IPOs remain somnolent and banks’ lending to corporates has yet to revive. The deadline imposed under the Indian Bankruptcy Code plus flexible resolution plus injection of funds create good conditions for resolution and revival of stressed assets, as well as improvement in the credit culture. Since the IBC has been triggered, however, in the small window of time available before liquidation, current restructuring schemes must be allowed to work with full flexibility. Even as the stick of the liquidation deadline pushes banks towards resolution and revival of assets the carrot of easier resolution must be made available, supported by easier macroeconomic conditions. Lender and borrower needs could drive a flexible merging and fruition of on-going schemes.

Fresh loans to stressed corporates, after resolution that establishes future viability, should be classified as standard to incentivise banks to resume lending. Research on macro-prudential regulations supports flexibility in restructuring schemes. It recommends relaxation especially where regulations are binding on provision of credit. PSBs must also adopt a risk-based approach to identify and lend to companies with good business prospects and let weak companies exit early. If the Monetary Policy Committee is following flexible inflation targeting then it must focus on inflation first and growth second, and it cannot bring in financial stability considerations. It is not correct to argue that lower rates will allow weak parties, with stressed assets, to survive. High rates have contributed to the build-up of unsustainable debt and falling interest coverage ratios. There has been too much strictness.

It is true there is considerable froth in stock markets, but this cannot be an argument to keep interest rates high. Rather, regulation is required to encourage the cash over the option market, extend trading to more stocks, develop SME exchanges and make IPOs easier. That domestic savers as well as foreign investors are investing in stock markets makes for more stability.

The supply side has to improve for macroeconomic stimulus to be feasible. Improvements in public services, especially education and health, are still limited. But there is voter pressure now on better delivery. Niti Aayog can encourage competition and adoption of best practices in these State subjects. This will aid self-employment at higher productivity. This is the future of jobs for young people even in advanced countries as technology changes job structures.

Agriculture is another area that requires attention. High value horticulture production that is expanding in rural areas is feasible at low scale, but it is high risk. As power supply improves, loans for processing and storage facilities can help farmers as well as provide jobs to rural youth. Farmers can get better prices, even as consumer prices fall, if intermediary monopoly margins are squeezed.

The writer is a professor of economics at Indira Gandhi Institute of Development Research, Mumbai

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