With both fiscal and monetary policy at the end of the road, there is little that can be done in the short run. pvt sector can’t pull all the weight either.
Can anything really be done about the economy? Practically speaking, if it were so easy for a government to turn around an economy, there would be prosperity all around. All kinds of suggestions have been put up by the wise counsels and every option explored. Yet, it does not look like there is an imminent solution. The fact that there is little official acceptance that the slowdown is deep and hard to reverse, is important because as long as we believe that things are only transient, the deterioration will be fast. Using the argument that we are the fastest-growing economy sounds good for the pulpit, but does not really provide solace. The problem is three years old, starting with demonetisation, and the policy of ignoring the consequences has led to the present state.
What can the government do? The government, to its credit, has done virtually everything that can be done to revive the economy short of announcing doubling of the fiscal deficit. The motherhood statement often made that more reforms are required is open-ended and not specific. The government has addressed issues pertaining to the auto and real estate sectors besides enabling flow of credit to the SMEs. Its expenditure on projects is on schedule. Policies relating to recapitalisation of banks, merger of PSBs, disinvestment, labour laws, addressing the NBFC crisis, etc, have all been put in place.
RBI has, on its part, taken decisive steps in lowering the interest rates and opened the door to a regime of lower interest rates. Yet, there has been limited progress made by banks as the credit-risk factor lingers, and they are reluctant to lend. They have been goaded to lend to SMEs which may not be wise because it can build an adverse portfolio of NPAs. While retail loans are the flavour, it should be realised that if the slowdown continues, there is a good chance of delinquencies increasing as all home loans are taken with the assumption that the salaries are paid on time, and the bonuses and variable pay come in. Any pause here can have serious consequences for the system.
The economy is in the classic state of liquidity trap which was highlighted by Keynes during the time of the Depression, when lowering of interest rates ceases to affect demand for funds. This has happened in Japan and the euro region too, where interest rates have lost their relevance. The rudimentary theory of demand, supply and prices does not work as the underlying assumption of ceteris paribus no longer holds in the present context. Credit risk perception is high and banks do not want to lend money to all and sundry given the NPA overhang.
With both fiscal and monetary policy at the end of the road, there is little that can be done in the short run. Increasing the spending of the government by say Rs. 2 lakh crore is an option which looks unlikely, as it sends wrong signals to the market. Therefore, the ball is back in the court of the private sector.
The private sector would rather not get into infrastructure given the challenges of finance. Usually, these projects would not have a good rating to be able to command funds from the debt market. Further, with several large companies waiting for the IBC to resolve the debt issue, possible investors may prefer to purchase them in the market rather than start afresh. Add to this the fact that consumption has slowed down and it means that there is surplus capacity in most industries which has made further investment non-viable right now.
Therefore, the path to recovery is going to be a slow one. Three ingredients are required which have to fall in place and will do so only over a period of time. First, the financial sector has to get out of the labyrinth. It started with the AQR affecting the PSBs and later the private banks. Subsequently, the NBFC crisis has dealt a blow to infra finance, real estate and SMEs, thus choking the financial system. This piece has to be set right, and the news of possibly more hidden NPAs on bank’s books could prolong the recovery process. It has literally been a case of survival of the fittest in the financial world. This is within the control of the government, and RBI has to be expedited.
Second, the rural economy still holds the clue to the recovery process and in a way is a necessary condition, though not a sufficient one. It is critical as it is independent of what happens in the industrial world, and hence, the optimal output and price are the key determinants to demand recovery. Any disruption, as has been the case with the vegetables and pulses crops this year, would upset the applecart as there are inflationary implications that make monetary policy even more difficult to conduct. Clearly, everything is not within the control of any entity, and, here, the states hold the key. The focus has to be on making farming more attractive and should be run as commercial ventures rather than a sector to be sympathised with through loan waivers and cash transfers. Policy has to aim at increasing productivity of land and providing end-to-end solution till the marketing stage. State farming has to be seriously considered.
Third, job creation is necessary to generate sustainable income that will generate demand. Employment unfortunately gets linked with growth and normally follows the latter and cannot be created unilaterally. Unless there are more households with spending capacity, consumption won’t increase. As corporates cannot employ persons and keep them on the bench (given that they have already lost pricing power in the last three years), the emphasis must be more on gig workers who are able to generate income by working on a contractual basis as consultants. In the medium term, the education system should bring in courses that suit the needs of the day—specific engineering requirements or handling of back-office jobs, so that the human race does not head towards the standard courses of medicine, engineering and management. Demand will grow for such skill-sets, and short-term courses of 3-6 months which address these requirements will be appropriate.
Evidently, there are no quick solutions here, and it can be said that most alternatives have already been explored by the government with limited success. Removing administrative bottlenecks is a must; and retaining processes merely because there are legacy issues in various government organisations has brought impediments for entrepreneurship. This environment of doing business at the micro-level has to improve, and the federal structure involving multiple clearances and permissions needs to be done away with (just like what the GST has done) to smoothen the process. Getting in marginal improvements to break the World Bank Doing Business Code does not work except for getting in newspaper headlines. There has to be a deeper commitment.
(The author is Chief Economist, CARE Ratings. Views are personal)