With this collapse, several growth narratives of the past turn out to be myths.
GDP growth plummeting to 5% has triggered another round of downward revisions to FY20 GDP forecasts, closer to 6%, or even lower. The collapse in private consumption has punctured the one leg on which the economy stood. The elephant that was poised to run post-GST has been grounded, pushing the government’s $5-trillion economy dream further ahead. The extent of output collapse (three percentage points vis-a-vis April-June 2018) has surprised even the government’s worst critics, invoking a debate if this is cyclical or structural. Many consider it cyclical, including RBI, which also finds trend growth moderating since 2016-17. Lowered potential output suggests the story lies on the structural side.
Economists are advocating more structural reforms. That is for the future. What about the past? Modi 1.0 government introduced several big and small reforms, especially inflation targeting, IBC, RERA, demonetisation, GST, and improving doing business. Modi 2.0 should be reaping the dividend. Instead, growth faltered. What went wrong?
The inevitable comparison with the 2012 slowdown calls for revisiting growth narratives of the time. It is important to see how these hold out, as they guided Modi 1.0’s policy responses.
Policy Paralysis: The outstanding explanation of 2012 slowdown was ‘policy paralysis’—government failure in timely project clearances, mostly infrastructure, which stalled due to land acquisition, environment and forest rights issues. Attributed to weak leadership of a coalition government, the recommended solution was reforming governance—strong, decisive leadership could take quicker action. The new government cleared many stalled projects, sparking expectations of imminent investment revival. But, investment never recovered; it is probably more depressed. Private participants remain risk-averse to infrastructure exposure even as public capex is exhausted.
The ‘policy paralysis’ diagnosis was always overblown, limited, and evaded material issues of private risk-taking and sharing, external demand collapse, and other nuances, which ‘decisive leadership’ alone couldn’t resolve. As early as March 2014 (bit.ly/2k2CxSO), we apprehended that these narrow accounts risked skipping policy focus on ‘real’ productivity-enhancing reforms. Growth costs of overemphasising governance are now apparent.
Growth Domestic demand-driven; External Factors mattered little: External factors were given short shrift. The overwhelming conclusion was India’s growth was largely driven by a domestic demand-oriented investment boom; unlike China, and several other emerging markets, India relied less on exports. Growth decomposition, and econometric exercises reaffirmed this, attributing investment shortfall as the major cause. Added to evidence on stalled infrastructure projects, the verdict was that domestic policy uncertainties, not world recession, forced businessmen to abandon ongoing projects; scrap future plans. That India was no exception to a global downturn—prominent economies like Russia, Turkey, Thailand, China and South Africa experienced even sharper slowdowns in 2012-13—was ignored.
This led to subsequent neglect of exports, and trade policy. Exports lost competitiveness not just from rupee appreciation due to illusory external balance improvement but also from failure to recognise the trend fall in world trade volumes, which, ideally, should have urged appropriate structural reforms to gain an extra edge. While our emerging market peers focused upon efficiency-productivity improvements through structural reforms in that period, the underplayed role of external conditions proved costly, with excessive faith on propping up domestic demand, including from strengthening currency.
Structural Reforms: The failure to make India’s factor markets, other institutions more flexible, and efficient, to lower trade-production costs in the post-crisis world was also attributed to an inept, coalition government. The new government did try to revise land acquisition rules, but lacked majority in the Upper House, leaving labour market reforms to state governments. But, Modi 1.0 instituted other signal reforms, whose growth outcomes deserve appraisal.
Inflation Targeting intended to resolve India’s high-inflation by anchoring expectations, disciplining wage-price spirals to deliver fairer returns to savers, and lower costs for producers. The promise was low and stable inflation would lay the foundation for strong and sustainable growth for many years. Inflation did lower, but growth dropped; higher returns haven’t quite excited savers as declining household financial savings testify, while producers and several commentators blame high real interest rates for discouraging investment. Contextually, the IT reform missed reading the secular decline in global inflation, which major central banks have failed to revive. India kept real interest rates astronomically high in this environment, extracting severe output sacrifice.
Demonetisation, a ‘structural reform’ to encourage formalisation, digitisation, and increase public revenues and savings by discouraging cash holdings, eliminating black money proved nothing as such. But, it deserves flagging the economy struggles, today, from a depressed informal sector, as commentators debate about how to address it!
GST, the ‘one nation-one tax’ ushered in Parliament’s central hall in July 2017, estimated GDP gains between 0.9-1.7%, and higher exports in the 3.2-6.3% range.
Other benefits were structural improvement in fiscal balances from higher compliance and revenues; positive direct tax collection spillovers from removed distortions; better governance from increased transparency; new job opportunities; decentralisation of production, formalisation, etc. Two years later, none of this is visible: GDP and tax revenue growth have precipitously slowed, and market share gains of organised firms are reported to be tapering off even as transport times are reduced and logistics improved. Did GST follow too close after demonetisation, affecting careful designing and implementation?
Insolvency and Bankruptcy Code provides legal exit and resolution options for failed businesses, imparting certainty. However, its impacts upon existing and potential/new investors need differentiation: IBC increases uncertainty for existing investors, deterring them from further investments seeing the fate of past ones; new investors do have more future certainty, but do not foresee demand. We need to recognise this dynamics to understand that IBC has not yielded any growth benefits.
Banking sector stress was recognised mid-way through Modi 1.0, which responded to NPA recognition, resolution, recapitalisation and reform. The process has been slow, and is still incomplete; recapitalisation has been inadequate as regulatory and growth capital needs are consistently underestimated, and fall short; public banks’ reform misses key governance problems. Then, some private banks got similarly sullied. Growth was surely pulled down.
Excess Welfare Spending or Dolenomics: Excessive welfare spending squeezed public capex, worsened expenditure quality, and underpinned the severe resource constraint by 2012. This ‘dolenomics’ analysis perversely influenced public spending by Modi 1.0: it neither controlled nor reformed revenue expenditure, but rather expanded it, scaling-up capex through large off-budget borrowings. The outcome is counter-productive, as this pattern pushed up private borrowing costs—a serious mistake—creating further resource constraints while the private investment shortfall persists.
The partial growth narratives of the 2012 slowdown led to investing of political capital in inadequate policy actions, missing deep-seated reforms to raise productivity in a stagnant post-crisis world. Potential output is, no doubt, lowered with no fresh capital stock addition for one decade, falling labour force participation and lagging productivity. As growth collapses once more, there is little choice but to take a hard look at what holds India back the most: the high costs of production, and trade transactions. The need of the hour is to recoup its lost competitiveness, unaddressed since the 1991 reforms. There is a majority government in both houses. This political dividend needs harnessing to reform land, labour, markets, and institutions for conversion to a growth-dividend and job-creation.
(The author is New Delhi-based macroeconomist. Views are personal)