The Narendra Modi government is reeling under extreme pressure to fix the economic growth, which had hit a three-year low in the first quarter of the current fiscal at 5.7%. And, fiscal stimulus is being touted to be the possible solution, but JP Morgan’s Chief India Economist Sajjid Z Chinoy does not agree. He says India is currently facing negative supply shock which cannot be corrected through a positive demand impulse. In an article published in the Indian Express, Sajjid Z Chinoy opines that a fiscal stimulus — in the wake of an adverse supply shock — will simply stoke more imports and result in a larger current account deficit.
Here are six key takeaways:
Diagnose the problem
The economist says that the government first diagnose the economic slowdown before taking any decision to fix it. He says India’s slowing GDP has been slowing for five quarters: first, due to oil-windfall and de-leveraging; second, due to demonetisation and the GST. The economist says that despite the slow-down India’s current account deficit is growing.
Imports on rise
The reason India’s current account deficit is growing is because, despite the slowdown, manufacturing imports have grown in recent months. While growth has slowed from 6.1% to 5.7%, the current account deficit has quadrupled from 0.6% to 2.4%.
Imports are growing when demand is slowing
India’s growth was largely impacted from oil whose nature was transitory and temporary. The slowdown in March 2016 began when oil prices began to stabilise, and therefore “was an inevitable consequence of the oil windfall rolling off.” Later, demonetisation and the GST took centre stage in the slowdown. It is, however, important to note that imports contracted almost 5% in the before demonetisation, but have been growing at 13% since then. Sajjid Z Chinoy says stronger imports alone subtract 300 bps from the headline growth.
Why did imports begin to pick up?
Sajjid Z Chinoy says imports began to pick up because the domestic supply chain was disrupted post-demonetisation and the GST, mainly SMEs, and that got replaced by imports. The disruption caused by the GST and demonetisation was inevitable, Sajjid Z Chinoy says, as it aimed to formalise the economy and may eventually lead these supply chains through formal channels in the future.
Sajjid Z Chinoy says if the supply shock caused by demonetisation and the GST is transient, it will self-correct. But if it continues, the answer to this crisis is not fiscal stimulus. He says fiscal stimulus — in the wake of an adverse supply shock — will simply stoke more imports and result in a larger current account deficit.
The solution will come from supply-side
Since the problem is the supply-side shock, the answer should the be the supply-side solution. Sajjid Z Chinoy says that the government should avoid demand for a stimulus and instead focus on improving the regulatory and business environment for informal SMEs, improve their access to credit, resolve teething GST problems and simplify the burdens of firms competing in the formal sector. He also suggests that the government need to push hard on the stressed asset resolution.