Ananya Roy
Nirmala Sitharaman is set to announce her maiden union budget on the fifth of July. This would be the first budget under Modi government’s second term, and is oddly reminiscent of the budget presented in July of 2014. I say “reminiscent” because we again have Modi at the helm after posting a landslide victory; and “oddly” because the Indian macro environment today stands in stark contrast to what it was in 2014.
Let’s start with what has been sparking this feeling of déjà vu. The economy inherited by Modi had grown by 6.4 percent in the year ending March 2014. Reforms, lower interest rates, and infrastructure push were able to accelerate economic growth to as high as 8.2 percent in 2016-17. Fast-forward to the present day, we appear to be back to square one - growth has slumped to a 5-year low of 6.8 percent in the latest fiscal year and, once again, we have handed Modi the reins as we watch starry-eyed, waiting for him to turn the economy around.
However, it’s only the headline growth number that is back to 2014-levels. The problems faced by our economy today are, in a sense, brand new. The India of 2014 was choking as soaring oil prices and consequent high interest rates threatened to snuff out growth. India of today is faced with a few crises of our own making as our financial institutions are doubling over with pain, along with reverberations from global trade conflicts and geopolitical tensions. Perhaps the biggest difference is that Donald Trump wasn’t the US president back in 2014 and there was no talk of a new trade regime.
The saving grace during Modi’s first term had been a fall in crude prices from the highs of $100+ per barrel to the much tamer levels of $65 a barrel today. The fall in food prices was serendipitous too – monsoons and global prices pushed food inflation (which constitutes 40% of the CPI bucket) down to 0.2 percent in FY2019 from 4.9 percent in FY2016. Together, they were able to bring the benchmark inflation level down to nearly half of where it stood in 2014. This finally gave our central bank enough room to bring down interest rates almost monotonically from 8 percent to 5.75 percent in the five years leading up to June 2019. Notwithstanding the concerns around inefficient monetary transmission, the policy rate reduction did boost growth.
But, the higher they rise, the harder they fall. Rising bad loans and frauds led the way to more stringent NPA management, squeezing out banking credit. NBFCs followed soon after, with asset-liability mismatches and a liquidity squeeze. While our financial institutions are cleaning up their mess, credit in the system has dried up.
As a result, consumption as well as investment have taken a hit. We are now seeing one red flag after another -- the growth in passenger vehicle sales recorded an 8-year low in April; inventory levels in the auto sector rose to unprecedented levels; investment rate has fallen from more than 36 percent in 2014 to a little short of 30 percent in 2019; and gross domestic savings rate has fallen to nearly 30 percent from 32 percent during the same period.
Meanwhile, central banks of all major economies are turning dovish, pointing to the scary conclusion that this slowdown is a global phenomenon.
There is a structural underpinning to this slowdown and thus, an investment stimulus is as vital as a consumption stimulus in the upcoming budget. While rationalizing GST rates, pushing up income tax slabs, direct income transfer to farmers, and other similar provisions will have the desired effect as consumption and savings boosters, the long-term problem in the economy needs to be addressed through structural measures.
Higher infrastructure allocation is one of the ways to go. Since the maiden budget of Modi 1.0 allocated Rs 1.91 lakh crore to infrastructure in 2014-15, it has grown at a commendable compounded annual rate of 33 percent to Rs 5.97 lakh crore in 2018-19. The present state of the economy warrants renewed government focus on infrastructure, and not just through higher allocation, but also through more reforms and smoothing out the glitches of previous reforms. The key to growth lies in liberalizing land, labour and capital markets.
When it comes to the current credit paralysis, the asset-liability mismatch underlying the liquidity crisis currently plaguing some NBFCs is more pronounced for housing finance companies. So, housing credit has experienced a bigger squeeze. In order to boost housing finance, the budget could increase tax deductions on interest and principal repayments towards home loans. Reduced deductions on long-drawn projects may also warrant a second look. Longer term solutions include measures to revitalize confidence in our financial institutions to unclog credit channels, and enhancing the breadth and depth of bond markets as alternative long-term sources of credit. Of course, the onus for this lies as much on RBI as on the government.
Any consumption boosting measures implemented by the government pose upward risks to inflation. Despite normal monsoons predicted by the Indian Meteorological Department, delayed rains in many states of the country have pushed up food prices. Even crude prices have been on a general upward trend since the beginning of 2016 and continue to remain volatile in the light of rising geopolitical tensions. However, at the current level of barely over 3 percent, inflation should not be too high on the government’s list of concerns.
While discipline has helped contain the fiscal deficit to the target of 3.4 percent in the latest fiscal year, as RBI deputy governor Viral Acharya has pointed out, overall public sector borrowings now stand at 8-9 percent of GDP. Public sector borrowings sometimes spill over to government expenditure whenever a government step-in is needed. BSNL needing fresh government infusion for salary payout is the most recent example of such a spillover.
As lower tax collections in the wake of slowing growth drag down government revenues and with the Bimal Jalan panel having once again deferred its recommendations on offloading a portion of its reserves, the focus on curbing tax leakages is expected to continue with renewed vigour. Thankfully, the government can flex its political muscle now more than it could in 2014 to implement the non-populist measures required to pull the economy out of its current slowdown.
(The author is a fund manager. Views are personal. She tweets at @anayaroycfa)
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