Welfarist direction must continue. Economic revival will require transformative thinking from the finance minister
The state of the economy along with the continued uncertainty surrounding the global battle against Covid makes this year’s budget exercise potentially tricky for the finance minister.
Let me start with the good news. Almost all relevant agencies are forecasting India’s real GDP growth in 2021-22 to clock above 9 per cent. After the devastation of the last two years, this is a cause for cheer. The bad news is that a lot of this growth pick-up is because the economy had contracted relative to the pre-pandemic period. Consequently, the base on which the economy grew was smaller, which automatically makes measured growth greater.
To get a better sense of how devastating the Covid contraction was for the country, consider this: India’s real GDP in FY2019-20 (the last pre-Covid year) was Rs 145.6 lakh crore. The NSO’s advance estimate for real GDP in 2021-22 is Rs 147.5 lakh crore. This 1.26 per cent real GDP growth since 2019-20 actually represents a significant loss of output due to Covid.
To compute this loss, we need an estimate of what India’s GDP would have been if Covid had not happened. Between 2014-15 and 2019-20, India grew at an annual rate of 7.1 per cent. If India had continued growing at 7.1 per cent between 2019-20 and 2021-22, the real GDP in 2021-22 would have been Rs 167.1 lakh crore. This is Rs 20 lakh crore higher than India’s 2021-22 GDP and represents the output lost due to Covid. Even at a more sedate 6 per cent annual growth, India’s notional GDP in 2021-22 would have been Rs 163.7 lakh crore, which is an output loss of Rs 16 lakh crore.
To put such losses in context, note that it will take sustained annual growth rates of 9.5 per cent for the next five years for India’s real GDP to just catch up with its pre-pandemic path based on 7.1 per cent annual growth. Clearly, the next few years are going to be crucial for the country.
A nation’s GDP can broadly be used for consumption, government spending, investment or net exports. To sustain growth rates over 9 per cent for the next five years, there has to be a sharp increase in at least some of these components. The facts of Indian growth though are worrisome. Between 2014-15 and 2021-22, the Indian economy grew on average by 4.9 per cent annually. The biggest driver of this growth was government consumption, which grew at 7.1 per cent annually. This feature of Indian growth has become even starker since 2017-18, during which the anaemic average annual growth rate of 2.9 per cent has only been held up by a Herculean 6.1 per cent annual growth in government consumption.
The other components of aggregate demand have been decidedly lacklustre since 2014-15 in their contributions to growth. Investment is stubbornly stuck at or below 30 per cent of GDP. Consumption growth has refused to pick up above 7 per cent even in this recovery year of 2021-22 when GDP grew at 9.2 percent. Lastly, the contribution of net exports to growth has been consistently negative. Hence, the Sisyphean role of government spending to sustain the Indian economy.
There are three policy options available for macroeconomic management: Fiscal policy, monetary policy and regulatory policy. The monetary policy tool has essentially run out of ammunition in India. The RBI has cut the repo rate by 250 basis points over the last three years. Yet, the 10-year government bond yield during this period has come down by just 70 basis points. Longer horizon corporate bond yields have barely moved. Even more damagingly, credit growth, despite the liquidity injection, has averaged 7 per cent during this period. This evidence suggests that there is just no demand for bank credit from either households or firms. At this point, the RBI is an emperor with no clothes.
The FM’s options are thus confined to using some combination of fiscal policy and regulatory reforms to manage growth. As we have seen, fiscal policy has been in overdrive over the last seven years as the government has engaged in aggressive welfare spending along with some capital expenditures on infrastructure. These need to be continued.
The regulatory side of policy, however, has been passive or intermittently regressive. Average tariff rates have risen by 6 percentage points since 2015. Competitive forces in a number of industries have taken a hit, with a few industrial houses acquiring concentrated interests in multiple sectors. While this may be an attempt at reproducing the East Asian industrial model of state-supported keiretsus and chaebols, it is misguided. Unlike East Asia, there is no link between these policies in India and export competitiveness. Hence, the Indian Aatmanirbhar variants are more likely to become protected, rent-seeking entities.
Given this background, it would be a mistake in this budget to aggressively reduce the fiscal deficit much below 7 per cent of GDP. The pandemic has wreaked havoc on poorer households, especially in urban India, as unemployment rates have climbed. Augmenting the MGNREGA and extending it to some categories of urban workers is crucial from a welfare perspective. Production-linked firm subsidies need to be augmented as well since that is the most effective way of stoking investment demand by firms.
Reversing the increases in import tariffs should be another policy imperative. It is the only way to jump-start exports, which also creates jobs. Import tariffs are equivalent to export taxes. This conceptual fact is, unfortunately, rarely grasped in policy circles.
There is some concern about fiscal deficits due to the public debt approaching 90 per cent of GDP. However, in the current environment, that concern is overblown. Real rates are barely positive if not negative and are certainly below the growth rate. Hence, this constraint should be ignored. Moreover, laying out an aggressive divestment programme would also alleviate the fiscal pressure.
The FM has a lot on her bahikhaata this year. The nation would really benefit from some transformative thinking from her.