The retail-wholesale inflation gap, which touched 10 percentage points (ppt) in September 2015, has sharply reduced to below 2 ppt since November 2016 as the two inflation rates converged.
Last fortnight has seen a glut of expert opinions concerned about slowing economic activities and suggestions to address the immediate problems. Most reflect a sense of panic and urgency! GDP growth, these commonly say, could decelerate further to 6% in FY20 from 6.8% in FY19; recovery could take one to two years, perhaps even more. It is the prospect of a slow recovery that is triggering panic, with the undertone the economy’s potential might have fallen sharply. A debate has stirred on whether the slowdown is structural, cyclical or a combination of the two. The prime minister though, in a recent interview, almost brushed aside these alarming views, nudging everyone look at the big picture and brighter future ahead.
Are these opinions a bit premature? Two significant reasons suggest a degree of caution perhaps. First is the familiar divergence between volume indicators (captured by most lead markers) and the value-added captured by GDP estimates compiled by CSO. Indications from these two variable sets have often diverged, with subsequent revisions in the past, particularly in FY17. This should not be lost sight of. For all we know, value-added may be far more robust than the current weakness depicted by volume indicators.
Second, the GDP deflator—a mix of WPI-CPI inflation rates, applied with varying weights across GDP sub-components—has undergone a sea change (see graphic). The retail-wholesale inflation gap, which touched 10 percentage points (ppt) in September 2015, has sharply reduced to below 2 ppt since November 2016 as the two inflation rates converged. If at all there was an element of overestimation because of inappropriate deflator use, lower growth estimates could be reflecting some natural correction rather than an actual slowdown!
With this caveat, a summary of explanations about the slowdown and its nature is appropriate. Causes, nature: One set of views emphasises adverse effects of high real interest rates. Another strand holds that past growth was excessively debt-fuelled; this has now run its course—consumers are exhausted by over-borrowing as the income boost from falling prices has worn off while businesses suffer converse effects of aggravated debt. Another opinion argues that the demand from better-off consumers has peaked while low-income populations lack purchasing power for currently produced/imported goods; the concomitant structural distortions, therefore, require correction. Other reasons offered are dampened sentiments and animal spirits from aggressive government policies to increase taxes; the role of adverse demand shocks such as demonetisation; dragdown effects of reforms such as GST, RERA, etc, on specific segments; and the lingering twin balance sheet stress (banks and corporates). An adverse external environment is another explanation; some point to the inappropriate exchange rate policy impact on exports. There is also currency of opinion about risk-aversion, liquidity and lending squeeze caused by the persisting NBFC crisis, which is popularly held to have retarded private consumption.
These insights are not analytically underpinned, e.g., corresponding aggregate fluctuations (GDP, interest rates, consumer spending, investment, employment levels, etc), if downswing is cyclical. Structural interpretations of the slowdown, too, require careful, deeper research.
Remedial policies: Many advocate aggressive monetary easing—another 100 basis points or more! For several years now, we have been sympathetic to easier monetary policy. But, RBI Governor recently said a 50bps cut would’ve been excessive, 25 bps too little; therefore, the MPC settled for a 35 bps reduction—a Goldilocks solution. The RBI’s intellectual ambivalence—fearful of inflation but implicitly desiring its return—is inexplicable when globally, central banks have failed to revive inflation; India is no outlier. One is not sure if RBI is willing to ease further unless inflation surprises on the downside. The finance minister, too, said both government and RBI are on the same page, indicating shared apprehensions about the inflation-growth trade-off.
Can India meaningfully devalue its currency for a competitive exchange rate? Impossible, given intense global scrutiny and prickliness about central bank interventions in forex markets. Further, lower imports resulting from weaker domestic demand and low oil prices could narrow the current account deficit. One should be content if the RBI can manage the rupee at current value given persistent capital account surplus.
What about fiscal policy? Fiscal rules, falling revenues, committed welfare spending and large extra-budgetary borrowings for revenue-capex spends limit this route. Advocates recommend large-scale asset recycling; such monetisation depends upon buyer appetite, suitable hair-cuts, and price effects when many assets simultaneously hit the market. Then too, the question if public capex will restore private demand and inflation remains. What if the past pattern perpetuates when neither private investment revived, nor consumer demand sustained?
If you cannot devalue or ease monetary-fiscal policies to counteract the demand slowdown, you are in a fix!
That leaves the government with the sole option of structural reforms—focus on a medium-term growth recovery. But, how long could the medium-term be? One is unsure, given the pervasive growth pessimism across economies. Just look back at India’s own structural reform efforts in the recent past: Demonetisation and GST were expected to spur formalisation, deliver growth boost in a couple of years’ time—so we should be reaping the growth dividend now with more tax revenues. Instead, we have a structural trigger—consumption slowdown at lower income consumer levels—which is a direct fallout of unplanned demolition of the informal sector. The new line of policy advocacy is that the formalisation drive ought to have accompanied distributive expenditure favouring the poor. But where are the tax revenues? The plot is familiar—structural reforms may be good, but outcomes remain unpredictable!
The prime minister expressed confidence on returning to a robust growth trajectory in the long term. Urging all to see beyond a budget or two, he highlighted numerous facets of active policy attention and intervention, committing to investment-led growth with a $100 billion target in five years. This may not comfort many—the UPA II had chosen this path and ended up dragging the banks and the economy into a deeper hole.
Hard choices: There is a hard option to break this impasse, provided the government is prepared for near-term growth sacrifice for medium-term gains. Can fiscal room for capex be created by revenue expenditure cuts, e.g., subsidies? Can corporate taxes be cut to improve returns on private investment? Expenditure-switching on these lines will recoup revenue losses from tax cuts, lower interest costs for the private sector. But this option lies in the political economy domain, and depends upon the government’s appetite to use its exceptional mandate for hard, unpopular choices.
Author is New Delhi based macroeconomist. Views are personal.