The problems of the economy stem from macroeconomic imbalances and corruption and unless they are addressed, the economy will not recover. The need today is not only for decisive leadership but also for a new, holistic macroeconomic approach
The Bharatiya Janata Party’s dramatic electoral victory is partly the result of the United Progressive Alliance’s failure to tackle the problems affecting India’s economy. A high rate of inflation that persists, declining growth, inadequate employment generation, fiscal deficit, current account deficit (CAD) and corruption all contributed to public disenchantment with the UPA. Therefore, expectations are high that the new government will tackle these problems decisively and bring relief to the public.
The economy’s rate of growth has declined every quarter since the end of 2010-11, i.e., for the last 12 quarters. The industrial sector has shown negative or near zero rates of growth. The services sector, the engine of growth for the economy, has experienced declining rates of growth. So has agriculture. In turn, this has led to sluggish employment generation. The problem has been compounded by the capital intensive nature of current investment which uses less labour and more capital, so that even when output rises, employment hardly grows. Most are forced to work in the informal sector at low wages which when coupled with high persisting inflation, causes economic distress and political unrest.
Increase in inequality
This state of affairs is due to the decline in the rate of investment from its peak of 38 per cent in 2007-08 because of the global economic crisis. It went up in 2009-10 but is down to about 32 per cent. It is still high compared to the figure of around 20-23 per cent in the 1990s. It rapidly increased in the 2000s leading to the boom of 2003-2008. The rapid increase in investment was engineered by allowing national income to shift rapidly in favour of the high savers — those who have high property incomes. This was evident from the direct tax data which showed that corporate tax collections boomed after 1999. This trend has led to a rapid increase in inequality in society and a slow rise in mass consumption so that the growth of the economy has depended more than before on rising investment levels.
Hence the crucial determinant of growth in the economy in the period after 2000 has been investment. As the investment rate declined after 2010-11, the rate of growth of the economy fell. Investment in the economy depends on private investment, both foreign and domestic and on public investment. There has been a problem with each one of them.
The BJP manifesto only presents a hint of its macroeconomic plan. Hopefully, the Union Budget will help clarify matters
Discredited model of investment
The situation has been aggravated by developments on the external and the fiscal fronts. The green shoots in the United States did not bloom, Eurozone went into a double dip recession, Japan continued its sluggish growth and the Chinese and the other BRICS economies slowed down. Thus, the growth rate of exports has been low. But, imports rose sharply due to the high import bill for petro products and the increase in the gold import bill. The consequence has been a high trade deficit and CAD and a decline in demand in the economy. This has also been accompanied by a reduced inflow of foreign investments so that the value of the rupee vis-à-vis the dollar declined sharply in the last few years. This added to the imbalance on the external front with speculation and a flight of capital aggravating it. The threat by credit rating agencies to downgrade the country has been looming large which could lead to an increase in cost of borrowing abroad and a rise in CAD.
Foreign investment has slowed down but it only constitutes around 10 per cent of the total investment in the economy. The bulk of investment is internal and this has slowed down due to several factors. One of them has been the unravelling of scams since 2009 and the subsequent intervention of courts. This has impacted the confidence of the business community which was used to employing crooked means to manage its investments and the markets. After the court interventions, there have been question marks over many decisions like allotment of spectrum, coal blocks and iron ore mining. This has unnerved businessmen who have lost the confidence that they can manage the business environment the old way.
Their confidence has also been shattered by widespread public protest against large-scale acquisition of land needed for major projects. This goes back to the days even before Singur. Resistance has continued in Jaitapur, Kudankulam, POSCO, Tata Mundra and so on. Some big ticket investment projects like the $12-billion project by the Mittals have been called off. The problem remains unresolved because the public perceives a loot of natural resources — land, air, water, spectrum, forests and mines — at its expense. So, the execution of big projects has slowed down. The private corporate sector has been flush with funds which it has not invested due to the uncertainty and sluggish demand in the economy. In brief, the slowdown in internal investment is a result of the discredited model of investment in the country which has been based on collusion between businessmen, politicians and the bureaucracy. Thus, for different reasons, both foreign and domestic private investment has slowed down.
The last element, public investment has also slowed down because of policy paralysis in the government and even more importantly due to the sharp cutback in Plan size in each of the last five years so as to keep the fiscal deficit down; compared to budget estimates, the actual has been less by Rs.5 lakh crore in these five years. This has led to a slowdown in investment in infrastructure and an aggravation of shortages.
Because of the slowdown in the economy, tax revenue increase has suffered. That is why the fiscal deficit has tended to increase. To keep it in check, the Plan size has been curtailed. But that sets up a vicious negative cycle. As the economy slows down, the threat of a downgrade by credit rating agencies increases, revenues of the government rise less and the deficit tends to rise, both of which lead to a loss of confidence and a further slowdown.
Can the new government tackle the difficult economic situation? Prime Minister Narendra Modi is reputed to be a “man of action” but the issue here is what action? The corporate sector has backed him in the hope that he will reverse the misfortunes of industry. The stock markets have risen sharply in the last few weeks. Can the new government simultaneously fulfil the hopes of business and those of underemployed youth hoping for a miracle?
Improving investor confidence
While the rise in the stock markets signals the flow of funds from FII, it does not mean that foreign direct investment will suddenly increase. Further, there is the danger of a speculative bubble building up — as in the past — which could collapse and adversely impact the investment climate. This could be triggered by the continuing easing of the Fed intervention in the U.S. — something that is ongoing. Even if foreign investment increases, it is a small part of the total investment so it cannot be the major stimulus needed. Domestic investment — public and private — needs to be revived. Large investment is going to remain hamstrung by environmental and other clearances and difficulties in acquisition of land unless laws are changed but that would take time. Transparency in business decisions is needed to revive investment, which also needs time. So, the only thing that can be done soon is to increase public investment, especially in rural areas where infrastructure is woefully inadequate.
Schools, dispensaries, roads, telecom, water, small irrigation and so on are needed urgently in rural India. This has the potential to create lots of jobs unlike the big investments and would be much less expensive than in urban areas because land is less expensive. Thus, it would benefit many more people and slow down the expensive and environmentally damaging urbanisation currently taking place. But this requires efficient governance.
In brief, the problems of the economy stem from the macroeconomic imbalances and corruption and unless they are addressed, the economy will not recover. The need today is not only for decisive leadership but also for a new, holistic macroeconomic approach — a break from the UPA’s policies. Unfortunately, the BJP manifesto only presents a hint of its macroeconomic plan and that too towards the end of the manifesto, as if like an afterthought. Hopefully, the Union Budget will help clarify matters.
(Arun Kumar is Sukhamoy Chakravarty Chair Professor, Centre For Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University, New Delhi.)