SEPTEMBER did not begin well for the Narendra Modi government. As it prepared for a makeover in the form of a Cabinet reshuffle with Elections 2019 in sight, news came that India’s GDP (gross domestic product) growth had slowed significantly to 5.7 per cent during the April-June quarter. This deceleration comes in the wake of a fall in growth rates from close to 8 per cent a year earlier to 6.1 per cent during the January-March period this year.
As expected, the government chose to attribute this trend to short-term shocks, which will not dislodge the economy from a 7-8 per cent growth trajectory that is considered to be the magical norm under the National Democratic Alliance (NDA). T.C.A. Anant, the Chief Statistician of India, whose real job is to oversee the preparation of the figures and not to explain them, declared at his press conference that the April to June deceleration was not the consequence of the botched demonetisation, but of pre-GST (Goods and Services Tax) apprehensions that had resulted in de-stocking. Wanting to clear their stocks before the new rules and rates applied, manufacturers chose to dispose of their stocks and not add to them with new production, was his claim. Since he had similarly declared when reporting the January to March deceleration that the trend cannot be attributed to demonetisation, the Chief Statistician was at least being consistent. The fact remains that a continuous deceleration in growth from 7.9 per cent in the first quarter of financial year 2016-17 to a three-year low of 5.7 per cent in the first quarter of this financial year cannot be dismissed as being the result of unwarranted short-term fears of some economic agents. What the figures do point to is a loss of dynamism in the principal commodity-producing sectors in the economy—agriculture and manufacturing.
The most recent deceleration is disturbing also because it has occurred at a time when the government has chosen to loosen its purse strings and sustain, if not increase, spending. According to figures from the Controller General of Accounts, Central government spending during the first four months of financial year 2017-18 (April to July) amounted to 38 per cent of the budgeted total, as compared with 33 per cent in the corresponding period of the previous year. This frontloading of budgeted expenditure should have had a stimulating effect on the economy in the short run. Yet, growth has slowed.
Moreover, export performance has improved considerably. India’s exports, measured in dollar terms, rose by 8.7 per cent during April to July 2017, compared with a fall of 3.6 per cent in the corresponding period of 2016. Although exports are by no means an important stimulus for growth in the Indian economy, this improved performance suggests that a poor global environment cannot be held responsible for the deceleration of growth in India.
That leaves the residual factor, which is private consumption and investment demand, the dampening of which must have been significant enough to overwhelm the stimulating effect that frontloaded government spending would have had. This contraction in private expenditure and demand has both long-term and short-term sources. The long-term factor holding down private investment is the deflationary environment in which the economy has been placed by the fiscal component of neoliberal reform. Ever since such reform has been pursued, beginning in the early 1990s, a declared goal of the government has been to rein in the fiscal deficit. Since such fiscal consolidation is favoured by foreign financial investors looking for evidence of “macroeconomic stability”, liberalisation of rules governing capital inflows and outflows makes fiscal deficit reduction imperative. So, in the late 1990s the government chose to postpone adherence to strict fiscal deficit targets and the growing accumulation of the stock of portfolio investment in the country forced it to adopt the Fiscal Responsibility and Budget Management (FRBM) Act in 2003. The FRBM Act effectively tied the hands of the government and has since its passage resulted in a decline in the fiscal deficit to GDP ratio to 3.5 per cent in 2016-17. Since this occurred in a period when the government sought to move to an investor- friendly tax regime, which capped and even reduced the tax-to-GDP ratio, a consequence has been curbs on spending that had an overall deflationary impact on the economy.
This, however, did not show through during the 2003-08 high growth years, essentially because of a spike in bank lending facilitated by the liquidity injected by large foreign capital inflows. Consumption and investment spending financed by this credit boom also served as a stimulus for growth. Besides a sharp increase in retail lending, especially for housing, commercial bank exposure to the large corporate sector increased hugely. Much of this lending financed investments in the infrastructural area, which are characterised by long gestation lags and low returns. Since the government chose to privilege such investments by the private sector, huge loans for highly leveraged capital-intensive projects were advanced on the basis of the government’s hype. By the start of the second decade of this century, it was becoming clear that many of these projects were failing to generate cash flows to meet the interest and amortisation payments on the loans taken. What followed was a huge increase in non-performing assets, which is proving to be an intractable problem for both the public sector banks and the government.
Having had to sacrifice profits or incur losses on account of provisioning for these bad loans, banks have turned cautious, leading to a sharp slowdown in credit growth in recent months. The effect of this on demand and growth has been so adverse that even when the government sustains spending, demand is depressed and growth falters. Read in this fashion, the deceleration in growth in recent quarters is by no means the result of self-correcting short-term disturbances or shocks. Rather, the downward trend is the result of the inability of the system to sustain the artificial stimuli that the neoliberal policy environment had facilitated. Growth that was riding on a credit bubble has proved unsustainable, and the economy is in deceleration mode.Beginning of the bust
This, in fact, may be the beginning of the bust unless the government can find alternative ways of propping up growth without violating its self-imposed fiscal consolidation measures. Recent actions signal three possibilities. The first is to accelerate privatisation and strategic sales so as to substantially increase the volume of non-debt creating capital receipts that are excluded from the calculated fiscal deficit. Privatisation receipts have been set at a high of Rs.72,500 crore in Budget 2017-18. They could be raised further. The problem is that selling assets to finance current expenditures does not make financial sense. But a desperate government is hardly interested in fiscal correctness.
The second is to transfer the so-called “profits” of the Reserve Bank of India (RBI) in the form of dividend payments to the government, which “owns” the central bank. There are no commercial operations that the central bank undertakes, so its profits are largely the result of income accruing from bank note issue (seigniorage, or the profit accruing from the difference between the face value of money and the cost of physically producing it) and interest income from the holding of bonds and bills, both domestic and foreign, resulting from its asset and liquidity management measures. The budget had provided for a Rs.58,000-crore transfer of such “paper profit” from the central bank to the government. But, hit by demonetisation, the RBI has thus far delivered only Rs.30,659 crore out of its Rs.44,000 crore surplus for 2016-17. The comparable transfer figure for 2015-16 was Rs.65,876 crore. According to reports, the government is pushing for more—perhaps the whole of the remaining Rs.13,000-odd crore.
Finally, there is a real danger that having pushed through the GST and put many commodities in the higher slabs, the Centre would turn to indirect taxes on goods and services to garner the revenues needed for enhanced spending. Since the rules regarding sharing of these taxes between the Centre and States have been laid out, the aim would be to set GST rates high enough so that the States would not have to be compensated for revenue losses, while the Centre would see a substantial increase in revenues that could be attributed to better compliance. The government seems to be betting on this. Whether it will win the bet or not is yet unclear. But that victory can only be partial. High rates that resolve the revenue problem can lead to destabilising inflationary trends. On the other hand, if revenues cannot be hiked and fiscal deficit targets have to be met to please international finance, expenditure must remain lower than what is needed to reverse the deceleration in growth.
As the NDA looks to win a second term with a similar majority in 2019, this is a problem it will have to contend with. It is a problem that does not lend itself to easy resolution.