Response to What Should We Do About the Indian Economy

Economic Slowdown: Is Enhancing Rural Demand the Key?

Ashok Kotwal and Pronab Sen have done an extremely insightful and detailed analysis of the current malaises infecting the Indian economy in their article "What Should We Do about the Indian Economy?" (4 October 2019). Basing their analysis around the dual structure of the Indian economy, they highlight the phenomenon of India's failure to industrialise.

They emphasise two key constraints currently facing the Indian economy, viz., (a) a sustained slowdown of investment; and (b) a weak financial sector that is unable to finance infrastructure. They suggest a rural-led strategy as the way ahead.

I am broadly in agreement with their arguments and venture to highlight a few nuances that could have been considered.

There has been a sustained deceleration of India’s growth since the UPA-2 regime (continuing till date) and this declaration has been across the different sectors of the economy (Table 1; Mohan, 2019).

Data issues, particularly the change of the base year for GDP measurement from 2004-05 to 2011-12, has, of course, made comparison across years quite difficult. The growth numbers reported in Table 1 are a combination of: (a) the old GDP series (i.e., with 2004-05 base) till 2012; and (b) the new series (i.e., with 2011-12 base), thereafter. If one takes the new GDP series since 2005-06 then the claim of a sustained deceleration is no longer valid. A deceleration is, of course, consistent with the basic argument of Kotwal and Sen.

The authors correctly point out that a key factor in the growth deceleration has been a slowdown of investment. Incidentally, private consumption suffered too in 2012-18. Government consumption, on the contrary, went up earlier during 2008-12 reflecting the impact of the fiscal stimulus adopted in the aftermath of the global financial crisis. Finally, notwithstanding the deceleration, in terms of macroeconomic stability, the Indian experience has been quite noteworthy. Inflation by all accounts has come down. The current account deficit too has remained manageable. Of course, opinions could differ regarding the reasons behind such macroeconomic stability.

Insofar as the banking sector is concerned, there was actually a reduction of non-performing assets (NPAs) during the period 2003-2008 as a result of the various efforts initiated at the time by the RBI and the Government (Mohan and Ray, 2018). An interesting development in this context is the recent Supreme Court judgment whereby the February 12, 2018 circular of the RBI (that tried to ensure credit discipline among the commercial banks) has been effectively struck down.

Kotwal and Sen highlight the problem of infrastructure finance and the emergence of hugely indebted Indian corporates. In this context, it needs to be noted that the consequences of the disappearances of development banks like the erstwhile IDBI and ICICI have been very expensive. For the commercial banking sector to extend lending for infrastructure is simply beyond their balance sheet strength because of the asset-liability mismatch. An important solution in this respect could have come in the form of establishment of a Wholesale and Long-Term Finance (WLTF) bank that the RBI talked of in a 2017 Discussion Paper.

Having probed the difficulties of pursuing a strategy for industrialisation, Kotwal and Sen focus on making the rural sector the new engine of growth. The may be necessary but will it be sufficient? After all, the share of agriculture in India's GDP is around just 15 per cent. Moreover the issue of agricultural income tax has been a non-starter since time immemorial. Of course, rural demand does not necessarily mean only agriculture, it could extend to rural industries as well. But, when the slowdown in the economy is widespread, the policy makers may need to fire multiple triggers. 

While increasing rural demand could definitely be one of the means to boost demand, the Government cannot pursue such a path effectively as long as it operates within the narrow confines of traditional fiscal arithmetic. Remember that the fiscal deficit went up from 2.5 per cent of GDP to 6 per cent of GDP within a year of the pursuit of a fiscal stimulus in 2008-09. At a time when the economy is facing a deceleration of the GDP growth rate for the last five consecutive quarters, it may be necessary to shed some the conservatism associated with the fiscal deficit. 

Finally, completely unrelated to the article, I have always found it difficult to reconcile the claim of structural constraints impeding economic growth in India with India's remarkable improvements in the World Bank’s ranking of Ease of Doing Business from 130 to 77 over the last three years. 

Is something amiss in these World Bank rankings?

References

  • Mohan, Rakesh and Ray, Partha (2018): "Indian Financial Sector: Structure, Trends and Turns", in Ulrich Volz, Peter J Morgan and Naoyuki Yoshino (eds): Routledge Handbook of Banking and Finance in Asia, London: Routledge.
  • RBI (2017): Discussion Paper on ‘Wholesale and Long-Term Finance Banks’, available at: https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&am...
Partha Ray, IIM Calcutta
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