As the euphoria over a historic victory in the general election of 2019 settles and the Bharatiya Janata Party (BJP) gets down to government formation, a challenging economic agenda awaits the new Finance Minister. Important economic indicators are flashing red indicating a slowdown in the economy.
Dismal picture
The financial sector is gasping under a liquidity crunch. A crisis is building up in the NBFC space that could snowball across the entire sector and worse, even the economy itself. This, even as banks are still clawing their way back to health after digesting large write-offs.
Making matters worse is the fact that policy-making has been at a standstill for more than two months since the election schedule was announced. And, come May 31, we are likely to see a dismal set of fourth quarter GDP numbers being announced by the Central Statistics Office. Going by the high-frequency data on the economy, it is likely that GDP growth in the fourth quarter of 2018-19 will be below 6.5%; it was 6.6% in the third quarter that ended December. At this rate, it might be difficult to touch the 7% mark for fiscal 2018-19.
The picture is not as bad as it was when Narendra Modi assumed office as Prime Minister for the first time in May 2014 but there is no denying that there is cause for worry and the new government has to move quickly. So what’s on the plate?
Rescuing NBFCs
This should be the first priority for the new Finance Minister. Even as banks are showing incipient signs of recovery from the non-performing assets (NPAs) issue, the non-banking financial sector seems to be lapsing into trouble. Beginning with the IL&FS collapse, the NBFC space has been hit by one problem after another and the thread running through them all is the drying up of liquidity.
Even well-known NBFCs and housing finance companies have been hit by asset-liability mismatch; they have borrowed short-term funds and lent them to long-term projects leading to cash flow problems. As a result, they have been unable to meet commitments to their own lenders. The NBFCs have been crying hoarse for liquidity support from the Reserve Bank of India (RBI), but the regulator has been reluctant to do the one thing that will help them the most — open an exclusive funding window.
The central bank may have its own valid reasons for not conceding the demand but the truth is that there is a real crisis out there and a risk that the contagion will spread. Usually it is the real sector’s problems that spread to the financial sector but in this case there is a real possibility of the reverse happening. The new Finance Minister will have to work with the RBI and banks to resolve this issue at the earliest.
Drive consumption
The high-frequency data coming out over the last few months point to a demand slowdown in the economy. Commercial vehicle off-take has been in the negative territory for the last few months following a drop in freight volumes and also tariffs. Passenger car sales, that were weak through 2018-19 with growth of just 2.7%, actually fell by 17% in April, which is the sharpest drop in eight years. Two-wheeler sales fell by 17% in 2018-19.
Consumer durable and fast-moving consumer goods sales have been tepid too. Even domestic air traffic growth fell for the first time in six years in April. These trends are validated by the monthly factory output data — after a flat, no-growth February, output contracted by 0.1% in March.
In an economy such as India’s excessively dependent on domestic consumption, a fall in consumer spending spells trouble.
In its first term, the Modi government did an admirable job in pushing public investment to prop up growth; the new government should, in addition, push consumption spending. And the best way to do that is to put more money in the hands of the people by cutting income tax sharply. It requires guts and gumption to do this though, considering the overall commitment to maintain fiscal discipline.
Yet, this may be the much-needed fillip to consumption as it is the middle class which will go out and spend the extra money in its hands. This may also be shrewd politics as the middle class has backed the BJP in this election. In fact, this argument can be extended by suggesting a cut in corporate taxes as well to unleash the animal spirits in the economy. Remember P. Chidambaram’s “dream budget” of 1997 when he cut personal and corporate tax rates sharply and how it spurred growth?
In this respect, the outgoing government — much against its philosphical leanings — has behaved more like the previous United Progressive Alliance governments by sticking to high tax rates and refusing to cut them. Maybe it was scalded by the “suit-boot-ki-sarkar” jibe of the Congress but the stage is now nicely set for the new government to try an alternative economic approach more aligned to the BJP’s economic philosophy. Would it be too much to suggest that the Prime Minister place faith in the economist Arthur Laffer, who theorised that lower tax rates not only boost revenues but also spur economic growth?
Cutting taxes will be akin to administering a dose of steroids to private investment, which desperately needs a leg-up. In the 2018-19 Budget, Finance Minister Arun Jaitley cut corporate tax to 25% for companies with a turnover less than ₹250 crore, which account for 99% of those filing returns. It may not be a bad idea to extend the concession, at least partly to start with, to the remaining 1% that represents the cream of business.
Key tasks ahead
A return of private investment is crucial to ensure the other important objective of this government: creating jobs. As businesses invest more to expand capacities, hopefully more jobs will be created.
The introduction of Goods and Services Tax (GST) and demonetisation were in no small measure responsible for the slowdown in the economy. Despite frequent tweaks to rates, product classifications and procedures, the GST remains a work in progress and needs to be streamlined.
The best that the new government can do is to quickly move to a set of just three rates from the six now. About 62% of goods and services are now taxed at 18% and above, which is rather high. The median rate should be reduced to 12% in phases — certainly 16% to start with — given that the GST is a regressive tool that taxes the rich and the poor alike. Revenues have stabilised at around ₹1 lakh crore a month now despite a number of products being moved to lower tax slabs over the last few months. It is time to get bold and reduce rates to spur consumption. Widening the basket and stricter enforcement are better ways to increase revenues compared to high rates.
Meanwhile, the farm sector is crying out for attention too. The new government will certainly be focussing on the crisis in agriculture, and the outcomes will determine the health of the rural economy.
Mr. Modi expended tremendous political capital in his first term on measures such as demonetisation which had questionable returns. He should use his renewed capital now to push through important reforms that will help the economy break out of the shackles of middling growth and push it into a high-growth sphere.
raghuvir.s@thehindu.co.in
