The feeling of sluggishness is palpable. There are talks of stimulating the economy using fiscal incentive. This can be an innocuous medicine for reasons of (1) dosage, (2) potency, and (3) long lead time. First, the dosage. The government may throw Rs 50,000-60,000 crore as fiscal stimulus—about 0.4% of our GDP. Given the current moribund state of the economy, with 25-30% underutilised capacities, it is too tiny to have any impact. The current closure of capacities or lack of investments have not become so for 1-2% poorer realisations or profitability. While the figures vary for different industries, these are substantial—the range of 10-20%. We need a correction of this magnitude. The gaps in our competitiveness with countries exporting to us—China, ASEAN and Korea—is 10-15%; not a 1-2% pittance.
Next, the potency and wastage. Any incentive will reach both the units operating at full capacity and units with low utilisation and poor profitability. Units that are closed or are NPAs could hardly be revived with a ‘spread thin’ incentive, and incentives reaching units operating at full capacity will neither create incremental growth nor new employment. There will be wasted efforts.
Finally, the lead time. If stimulus is by way of income tax rebate, it will be a year or many quarters before the recipient reckons it in his decisions. If it is by way of indirect tax cuts, the recipient knows it is for a limited period and will not motivate him for taking a long-term investment decision. We need immediate actions; most fiscal measures take a long lead time to get results. It may be beyond 2019 that one would see perceptible results.
The economy is stuck at a low and unresponsive equilibrium. The current impasse is borne out of three factors:
1. High internal value of currency (low inflation targets result in high real interest rates);
2. Partially from high external value of the rupee and high real interest rates attracting too much forex flows, which are beyond the capacity of the economy to absorb;
3. Free trade with ASEAN that kicked in from January 2014 in full.
The ASEAN FTA increased supplies and kept prices under check. It made import parity the basis of price determination for manufactured goods. But it also eroded domestic industry’s profitability since manufacturing prices have hardly risen to cover inflation of inputs in wages and inputs from agriculture. It delivered the customer stable or reduced prices, but took away their jobs. India’s growth is creating jobs, but in other countries!
Somehow, inflation control has become the focal point of our monetary management, just like fiscal deficit is for Union Budgets. While fiscal deficit control is understandable, in a globalised economy when the product of every description could be freely imported, supply-shortfall-induced inflation is out of question. From pulses and rice to apparels to electronics to Ganesha and Navratri idols, everything can be imported. Supply-constraint-induced inflation is the least RBI or the government needs to worry about.
The contributory reason for our lack of competitiveness with other regional players is high external value of our currency. The sooner it is corrected, the better—either by devaluation or disincentivising inflows. But devaluation can cause inflation.
First, reduce debt limits available to overseas investors and adhere to them. There is no point accumulating reserves to earn 1-2% returns by paying 4-5% overseas as interest in dollar terms. Second, there could be a temporary tax on investments into India. This can be even for ECBs, investments into government debt and all inflows that are not required for physical imports. Taxing interest on GoI bonds will lower their yield and contain inward flows. There could be a surcharge on inflows until the related imports take place.
As a corollary, the government can mandate that fresh foreign investments can only be in new government bonds issued, on which the government can offer much less interest rate. Such issuances can be allowed for secondary trades; maybe a separate bond segment with lower interest will develop.
Right time for one-time correction
The government should bite the bullet, like it did with GST, and correct the near-22% overvaluation in one go. It can reset the dollar/rupee level at Rs 71-72—an 11% correction. The monsoon is good and agricultural inflation may not be a risk. If, there is excess production, a good forex rate might help evacuate some surplus so that domestic prices don’t crash due to oversupply.
Next is oil; the government can put a price cap. It can decrease its duties by a similar (to devaluation) percentage and retain its rupee collection at previous levels, yet manage to stymie inflation through oil.
That will confine inflation largely to manufactured goods. Most prices in the manufacturing sector are determined by import parity. A 10-11% correction would likely translate into a similar uptick in their prices, which could help factories (like textiles) to start chugging again. In any case, buyers of manufactured goods have had it too good for the last 5-6 years without much inflation.
Protecting pensioners and interest earners needs to be balanced with the interest of freshers in the job market. The total interest paid on all bank deposits, small savings and mutual funds is less than 5% of GDP. Those entering the job market and finding themselves without jobs will far outnumber those surviving solely on interest.
Currency correction will also solve NPA issues. A 10-12% increase in realisation will turn many industrial units from potential NPAs to preforming ones.
Currency correction will hit the problem where it matters. The dosage at 11% on the total value of trade (both imports and exports) is huge. It will alter domestic profitability and have an immediate impact.
Sure, forex borrowers will suffer. But those who have covered their exposure need not worry. For those who have not or partially covered, they have made good gains for the last 12 years on the trot. Why should they not be made to pay some back now?
An equilibrium cannot be corrected by fiscal stimulus, which will be better for rectifying confidence issues.
V Kumaraswamy, CFO/Head, Strategy, JK Paper; author of ‘Making Growth Happen in India’