This is how you can give consumption demand a leg-up

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Fiscal policy is often constrained by inherent trade-offs between short- term, politically viable goals of job creation and output growth, and less myopic policy shifts catering to structural changes in the economy. Closer to an election year, the former takes precedence, but an overwhelming electoral victory makes a strong case for the government to shift its focus towards less transient, better researched policy measures that are likely to find merit in their longevity. The ongoing consumption slump, in its persistent screams for reform, presents that increasingly urgent need.

The last few quarters have been hard for the Indian economy. The GDP growth figures have fallen for the fifth consecutive quarter and stand at their lowest in 17 years at 4.8 percent for Q2 of 2019-20 (quarterly GVA, gross value added).

To add to the woes, consumption growth has barely kept up with the already dismal GDP numbers, a cause of concern for an economy driven by demand. In addition, industrial production shrank for the third straight month in October 2019 by 3.8 per cent as output in manufacturing, mining and electricity sectors all fell as against a decline of 4.3 per cent in September. Even inflation specific to large sectors, including fuel and light, and transport and communication has been less than encouraging.

Multiple fiscal steps by the government and other monetary measures by the RBI have been taken, including five consecutive rate cuts, but to no avail. While some argue that these are the warning signs of a looming recession, others would agree that the economy is in a growth recession and needs rescuing.

At a time when an innovative policy is the need, it is worth noting that consumption is the trickiest aggregate demand component to change (in the Keynesian Y=C+I+G+X-M equation). Y stands for aggregate supply or output, C consumption expenditure, I intended investment expenditure, G government expenditure on purchase of goods and services, X stands for exports and M for imports.

Consumption is far less volatile than investment and almost untameable, especially compared to government expenditure.  Thus, major shifts in an economy’s consumption pattern usually point to more fundamental changes, more so when such changes exceed the theoretical business cycle downturn limit of 3-4 quarters. This argument is supported by the fact that the tried and tested monetary and fiscal policy measures, usually used as a buffer against business cycle fluctuations, have not fared too well in the recent past.

Thus, the state of the economy is pushing for long-term structural changes in policy -- a requirement most effectively addressed at the beginning of a government’s tenure. In line with the bold move to introduce GST in an attempt to streamline the taxation system, it is a good time for the government to step back and evaluate other pressing needs.

India is witnessing extremely rapid migration from rural to urban areas, which is coupled with a major downturn in rural consumption demand. The nature of employment opportunities available to such migrants, their ability to support families back home and changes in their spending patterns are thus increasingly important inputs to the total aggregate demand.

Given that the urbanisation trend is known and increasingly foreseeable, infrastructure spends and the direct transfer scheme that ease this process could foster growth by i) creating more jobs and better opportunities for rural migrants to urban areas, ii) building long-term assets in the form of better infrastructure, including government housing and iii) managing urban migration in planned, sustainable and growth supporting ways.

Paying heed to a change in the rural-urban composition and supporting the economy’s natural directional changes in this context could be the key to managing employment, human capital formation, macroeconomic expectations, and as a result, aggregate demand and resulting economic growth.

Another aspect of the consumption slowdown is that it began shortly after major policy changes including demonetisation and the GST reform. Regardless of the effectiveness of these measures in other spheres, one must realise that these were unexpected. Much in line with theoretical economics -- as Keynesians would be first to argue -- these reforms have left their mark.

However, their impact goes beyond short-term output changes. Large, unanticipated government policy changes often impact people’s perception of their ability to foresee future economic events and make them re-evaluate their future expectations. As any economist will tell you, expectations are the most prominent self-fulfilling prophecy of modern times. But frequent policy changes in the recent past have given the consumer little time to realign their expectations, leading to increased scepticism and risk aversion. This is exacerbated by the challenges faces by the banking industry, including the NBFC (non-banking financial company) crisis, the increased volumes of NPAs (non-performing assets), and scams such as the Nirav Modi fraud case. These incidents potentially erode the economy’s confidence in the banking industry, leading to lower financial intermediary function, and credit creation.

Holding off on the more conventional, even reversible, demand side measures such as temporary repo rate revisions and short-term reversible tax rebates for at least the next couple of quarters while focusing on a more long-term development agenda could give consumers the much-needed time to absorb the existing economic framework, realign expectations and regain confidence in the economy, all of which would go a long way in spurring both consumption and investment demand.

Given its parliamentary majority, now is when the government could seize the day by striking an optimal balance -- The need of the hour is lesser short-term regulation and greater focus on long-term goals. Intelligent use of this time would indeed allow this government the rarest of political wins.