On this edition of Digging Deeper with Moneycontrol, we will try and find an answer to just that question.
Rima M. | Rakesh Sharma
Prime Minister Narendra Modi's Independence Day speech articulated the aspiration that India will become a $5 trillion economy in the next five years. He said, "From 2014 to 2019, we became a $3 trillion economy. Before that, in the last 70 years, the country was a $2 trillion economy. We added $1 trillion to the economy in just five years. Now we are looking forward to making the nation a $5 trillion economy."
Just over a week later, the Reserve Bank of India decided to transfer Rs 1.76 trillion to the Modi government. As analysts pointed out, though nearly 70% of that money is RBI’s annual dividend that is regularly transferred to the Union government, the remaining 30% is from a contingency fund, the dilution of which could undermine the value of Reserve Bank of India’s investments. The point to be noted here is that this is the highest sum the RBI has ever transferred.
How and why was this done? The government accessed RBI's contingency fund after a green signal was issued from a committee headed by former RBI governor, Bimal Jalan. As reported by various news sources, there is severe cash crunch in the government coffers, thanks to the fall out from the underperforming Goods and Services Tax and demonetization, among other factors.
As Scroll explained, the Central government tax collection as a proportion of gross domestic product in 2018-’19 was a full percentage point lower than the budget estimates. We quote, "This shortfall amounted to Rs 1.7 trillion and was the largest gap between tax estimates and actuals in India’s tax history. To add to this, India is also facing a serious economic slowdown. This means that tax revenue is unlikely to pick up in the near future but also that the country is looking to the Union government to provide the economy a stimulus. However, given its own cash crunch, the government had little room to manoeuvre – which is why it has had to look to the Reserve Bank of India for help."
So how do we reconcile the present state of our economy with the aspirational vision of a $5 trillion economy? On this edition of Digging Deeper with Moneycontrol, we will try and find an answer to just that question.
How realistic is the idea of a $5 trillion economy?
Statements of optimism from leaders continue to pour in amid rumours that the RBI fund transfer mentioned above was allegedly one of the key reasons the previous Reserve Bank of India governor Urjit Patel resigned in December 2018. Even if we disregard controversies like this, we have to take stock of the employment statistics – among the few reliable indicators of the state of the economy.
As writer Himanshu pointed out in an August 1 Livemint piece, most indicators of the Indian economy in recent months confirm that it is slowing. He says, there is also a consensus that the economic slowdown is largely a result of weakening demand, most notably in rural areas. While slowing demand has obviously affected the overall growth rate, it has also contributed to declining availability of jobs in an economy already struggling with the spectre of jobless growth.
Suman K Jha also wrote an August 19 piece in Business World about the recent auto slump in India.
The piece informs that the monthly automobile sales dipped 18.71 per cent in July, the worst in the last 19 years. This dip was most staggering in the passenger vehicles segment, with sales plummeting by 31 per cent to 2,00,000 units.
We quote, "This has had a cascading effect – plants have been shut, and widespread job losses, especially of contract workers, have been reported. A Reuters report said that as many as 350,000 workers may have been laid off since April. Hero MotoCorp, Mahindra & Mahindra, Tata Motors, Bosch, Sundaram Clayton, among others, have shut their facilities for some time, due to the slowdown. The auto industry employs 35 million people directly and indirectly, which translates into about half of India’s manufacturing output."
In the same story Britannia MD Varun Berry had this to say and we quote, “Even for a Rs 5 product, if the consumer is thinking twice before buying it, then there is some serious issue in the economy.” Berry also claimed to Business World that market growth has halved.
West Bengal Finance Minister Amit Mitra recently listed some national economic indicators and we reproduce them here from the Business World story with minor edits
In the April-June 2019 period, new projects announced were 87 per cent less than the corresponding period last year.
While capital goods sector grew 9.7 per cent in June 2018, this year, it contracted 6.5 per cent in the same period.
IIP (The Index of Industrial Production) was 1.2 per cent in June 2019, while it was 6.9 per cent in the same period last year.
The manufacturing sector grew by 1.2 per cent in June 2019, way lower than 6.9 per cent last year June.
Above all, in the January-March period, GDP growth was the lowest in five years at 5.8 per cent.
The figures, but of course, tell us that a slowdown is here for real.
Former Chief Economic Advisor to the government, Arvind Virmani, told Business World that India is a domestically-oriented rather than an export-oriented country. The subtext in his opinion being that if domestic markets slump, the economy could suffer far-reaching aftershocks.
Godrej group chairman Adi Godrej, told Business World and we quote: “Many sectors are not doing well. The government has also introduced some bizarre measures like imprisonment for CSR violations. A fiscal stimulus would be most welcome.”
Whether the recent RBI bailout will serve as that stimulus remains to be seen. According to a report in the Indian Express on Tuesday, the government may use the money to push a big capital expenditure programme. This would offer a stimulus for the sluggish economy, according to some analysts.
Many factors behind the slow down
Exactly one year ago, a group company of the systemically important Infrastructure Leasing & Financial Services Ltd recorded its first default on repayment of commercial papers.
Business World says that the IL&FS crisis was the tipping point after which, NBFCs (non-bank financial companies) found it difficult to borrow from banks, and since they largely financed the auto sector, the sector was badly hit.
Demonetisation and an imperfect GST rollout added to the woes of the informal economy.
The Business World piece advocates simplifying GST, undertaking long term tax and financial, agricultural and structural reforms, in addition to a stimulus, to kickstart the economy to realise the $ 5 trillion vision by 2024, and cites Marico Chairman Harsh Mariwala who adds: “We also need to address land laws, labour laws, cost of capital, and ease of doing business.”
According to Business World, surveys indicate that forty four per cent of Corporate India thinks the $5 trillion vision is an unrealistic target, and only half of the figure say this is an achievable target. On the other hand, 48 per cent of India feel this would be difficult to achieve, while 20 per cent feel the opposite.
Will optimism and ideation do the trick?
On August 26, Hindu Business Line reported that 18 PSBs (Public Sector Banks) came together recently in Pune as part of the second round of the ideation exercise to help India become a $5-trillion economy in five years.
The report informs that heads of all 18 PSBs and Sujata Iyer, Joint Director, Department of Economics and Statistics, Government of Maharashtra, and RBI representative, MK Moon, were present in the meeting.
We quote, "AS Rajeev, Managing Director and CEO, Bank of Maharashtra, said the first stage of the bottom-up consultation process to generate ideas and review performance of banks and their alignment with national priorities was conducted at the regional level on August 17 and 18 by all PSBs, involving all branches within their regions’ jurisdiction. This was a first-of-its-kind consultation, where the branches were asked to review their performance, deliberate on the issues before the banking sector, and indicate on future strategies, and the way forward for the economy to achieve the government’s aim of a $5-trillion economy by 2024-25.
He added that the meet also focussed on the ways and means to increase credit to various sectors of the economy, enhance use of technology to bring about innovation, and enable big data analytics."
According to the Business Line piece, the idea of this meet was to aim at making banking citizen-centric, as well as more responsive to the needs and aspirations of senior citizens, farmers, small industrialists, entrepreneurs, exporters, youth, students, and women were discussed at the meeting.
Some sobering projections
While optimism and ambition are crucial for nation building, a reality check now and then is essential too. In August this year, PTI cited the latest edition of Economy Watch, where Ernst & Young (EY) said India will need to grow by 9% every year for five years continuously and raise aggregate investment rate to 38 per cent of GDP to achieve Prime Minister Narendra Modi's target of a $5 trillion economy.
In its latest edition of Economy Watch, EY said assuming India grows by projected 7 per cent in the current fiscal year ending March 31, 2020, the size of the economy will grow to $3 trillion from $2.7 trillion in the previous year. It will have to grow by 9 per cent in each of the five subsequent years to take the size of the economy to USD 3.3 trillion in FY21, $3.6 trillion in FY22, $4.1 trillion in FY23, incremental capital-output ratio 4.5 trillion in FY24 and $5 trillion in FY25.
Historically, India's average ICOR (The Incremental Capital-Output Ratio) during the three-year period from FY17 to FY19 has averaged 4.23. The highest achieved investment rate in India was 39.6 per cent in FY12.
We quote from the PTI report, "If the inflation rate is lower than 4 per cent on an average and if the exchange rate depreciation is higher than 2 per cent per annum, reaching the size of USD 5 trillion would be delayed even beyond these target years."
As EY pointed out, while the central government plays a four-fold role in determining the overall investment rate through its budgetary capital expenditure, spending through PSUs, policy initiatives inducing private investments and coordination with state governments, the Centre's share in the country's aggregate investment was actually quite small – at 1.6 per cent of GDP in FY19.
PTI adds that as per actuals from the Controller General of Accounts (CGA), this constituted only 5.1 per cent of the aggregate investment. After adding central PSU's capital expenditure of 2.4 per cent of GDP in FY19, the Centre's contribution to the investment increases to 4 per cent of GDP, which is 12.6 per cent of the total investment.
EY said and we quote, "This can be substantially improved. The center may therefore provide a policy framework to induce the state governments and the private sector to uplift their investment rates. Furthermore, if the central government can successfully reduce its revenue deficit, there would be room for higher capital expenditure with the same fiscal deficit.”
The roadblocks ahead
In July, Dinesh Unnikrishnan wrote for Firstpost that PM Narendra Modi's $5 trillion economy dream is impossible without answering a few basic questions.
The first being, if the dream of a $5 trillion economy by 2024 is mere wishful thinking or an achievable target? Dinesh also asked if we should target a much higher growth to accommodate millions of young skilled youth in the job market and lift the economy to the next level as the world’s next big manufacturing hub?
As the piece says, "Dreaming big is essential; for only a target-based approach backed by a solid roadmap has delivered in economies that have achieved great scale. Before targeting the $5 trillion mark, India will have to get its act together in a range of areas, unclog the sizeable number of stalled projects, remove policy shortcomings and blunders that were strictly avoidable. Finally, the government must understand the problem areas that are pulling it down in the race among peer economies."
The first problem, says Dinesh, is the slow pace of infrastructure development in the last decade. He adds that India is still at the position where China was 20 years ago in terms of infrastructure development. He cites the 2019 Union Budget by Finance Minister Nirmala Sitharaman that talks about plans with a pan-India focus to give a further boost to Sagarmala, Bharatmala and UDAN projects, besides the dedicated industrial and freight corridors. The plans are ambitious but the problem is resources, argues the writer.
We quote, "The government estimates Rs 100 lakh crore infrastructure investments over the next five years or an average Rs 20 lakh crore a year. This is a far cry from what is spent on infrastructure currently which is barely one-third of what is estimated. The question is, where will this money come from. India does not have powerful institutions that can fund long-gestation infrastructure projects. Banks do not have enough long-term liabilities to match such loans. Lenders have gone terribly wrong in the past by not following healthy lending practices."
He informs that about 70 percent of the banking system is at the mercy of the government for capital for its survival and India does not have a deep bond market to take up the financing burden. The state-insurer Life Insurance Corporation of India (LIC) has been overexploited to do businesses it has never understood, he says, and adds that there aren't many other options left to take up the infra-funding burden. The government's plan to borrow off-budget is risky and unadvisable, he warns, and asks just who will fund the multi-billion infra dream.
The issue with micro management and slow reforms
The Firstpost piece also warns us of the government's excessive involvement in businesses. We quote, "The government remains a majority, active participant in several entities including banks, airline, infrastructure firms. It controls 70 percent of the banking industry. This participation has resulted in a lot of money getting stuck in these entities. The government will have to exit these businesses backed by a solid, aggressive disinvestment plan to unlock this money." The slow pace of land and labour reforms has also been a major turn-off for investors looking at setting shop in the country.
Another suggestion is that the government work out an exigency plan to get private investors back since domestic consumption is dropping to dangerous levels. According to the finance ministry’s data, projects worth almost Rs 11 lakh crore remain ‘stalled’ or are having issues. Railways, roads, and power sectors account for more than half of these stalled projects.
The writer also argues that so far the economy has been largely riding on public money, and an economy which rides largely on government money for a prolonged period of time does not promise much to the economy in the long run. What is needed is the participation of private investors.
He signs off, "The government’s $5 trillion target is ambitious and a strong statement of intent. But this intent must be followed up with action supported by a clear action plan to succeed. Else, it will remain mere wishful thinking. The year 2024 isn’t that far."
What does a $5 trillion target mean for India?
Rajas Kelkar wrote in The New Indian Express on August 19 that while the Indian government has set an ambitious target of making India a $5 trillion economy over the next five years, expert opinions are divided vertically and gravitate between hope and despair. He also thinks that to achieve this target, the government will have to increase spending on infrastructure.
But what will this mean for how Indian citizens are taxed? The obvious conclusion is that the government’s direct and indirect taxes have to grow. We quote, "The Goods and Services Tax (GST) collection has to break the 1 lakh crore barrier every month consistently. There may not be any increase in rates. However, the government may bring more goods and services in the tax net or focus on increasing the number of taxpayers. In all likelihood, it will try to simplify tax administration further.
The same would apply to personal income tax. A committee of experts will soon submit a report on an overhaul of the Income Tax Act. It is likely to simplify taxation."
The writer says that you may expect a cut in exemptions and a lower tax rate over the next five years. He opines that individuals and businesses would be taxed for both the income and the expenditure. The government needs money to boost social and physical infrastructure and hence it would be safe to assume that taxes you pay would rise steadily in the next five years, he says.
What about your loans?
The New Indian Express piece says, a key impediment to fuelling growth is the inability of public sector banks to lend. The banking system is saddled with non-performing assets. They are unable to lend to genuine borrowers as they concentrate on recovering previous loans.
This, points out the writer, is despite rapid rate cuts by the Reserve Bank of India earlier this year. He says, "Banks are not able to pass on lower interest rates to borrowers. They are forced to keep aside money to provide for any potential losses due to bad loans. The government and the RBI would have to concentrate on bringing the overall interest rates in the economy down. That means loans would get cheaper over the next five years. With a rising inventory in the real estate sector and falling automobile sales, home loans and car loans would get more reasonable — the government, and housing and automobile industries will have to lead from the front to achieve the growth target."
What analysts have to say
Meanwhile Business Standard reported that Goldman Sachs sees more pain in store for the Indian economy as the current slowdown has lasted for over 18 months and is the longest incident of sluggishness since 2006.
Nikita Vashisht reports that in a recent co-authored report titled India’s Economic Slowdown, Andrew Tilton, Goldman Sachs' chief Asia-Pacific economist expects this slowdown to last at least a couple of quarters more.
A slowdown in the investment activity, tighter funding conditions, a decline in consumer confidence, high real interest rates, central government expenditure and monsoon were some of the factors that contributed to the overall sluggishness, says the report and adds that weak global macroeconomic conditions, and a negative fiscal impulse are assumed to be also a drag on economic activity.
While fertiliser sales and rail passenger traffic, says the Goldman Sachs report, were the only indicators that started to fall towards the end of 2018, several variables, such as agriculture credit, rural wage growth and imports of electronic goods have, in fact, been on a descent since 2017.
A Reuters report published on August 27, 2019 has also indicated that Indian economy likely expanded at its slowest pace in more than five years in the April-June quarter, and was pegged at just 5.7 per cent.
As we know, last Friday, Finance Minister Nirmala Sitharaman announced reforms to revive economic growth, including rolling back recent tax hikes on foreign and domestic equity investors and several measures for industries.
Moody's Corporation, an American business and financial services company, has cut India's GDP growth forecast for the calendar year 2019 to 6.2% from its previous estimate of 6.8% though it says that recent measures announced by the Indian government to stimulate economy will provide some support to investor confidence.
Samrat Sharma wrote a piece in Financial Express on August 27, 2019 to state that the country’s GDP growth has been moderating on account of both global and domestic factors and the prospects over immediate term don’t seem too bright.
The agriculture sector, he points out, is expected to grow by a mere 2.2 per cent in 2019-20.
We quote, "India’s economic growth rate, which was at about 8 per cent until a few years back, has been revised downwards. GDP growth rate for the first quarter of the current financial year is estimated at 6 per cent, while for the full year 2019-20, it is projected at 6.9 per cent in the August economic outlook survey by FICCI. Where industry and services are expected to grow at 6.9 percent and 8 per cent respectively, optimism in the growth of agriculture and allied activities is still moderate.”
Sharma adds that at 3.7 per cent, the retail inflation is expected to prevail below the RBI benchmark, whereas the industrial production is expected to grow by 4.5 per cent in the current financial year. Provided the global environment of slowdown, economists believe that it is extremely challenging for the Indian economy to reach the 8 per cent GDP growth mark and to sustain at that level in the next three to four years.
The roadmap ahead
The Financial Express piece cites economists who have suggested that boosting the agriculture sector, strengthening MSMEs, undertaking factor market reforms and enhancing avenues for infrastructure financing are the key areas that can improve the economic scenario if immediate attention is given. The FICCI survey mentioned that the availability of adequate and high-quality jobs persists to be one of the biggest challenges in the economy as there is a continued over-dependence on farm sector for employment.
The piece also says that from a regulatory standpoint, the government bond market, the corporate bond market and the equity market is treated separately in India and the same needs to be corrected.
Some realistic stock taking finally
Mihir S Sharma also wrote in Bloomberg on August 27 that the Modi govt has finally embraced the reality of Indian economy's troubles after The Reserve Bank of India, the International Monetary Fund, investment banks and ratings agencies recently cut their estimates of 2019 growth sharply. The piece says that while some believe India’s official statistics may overstate growth by as much as 2.5 percentage points, even government statisticians are expected to release this week a more sober estimate for GDP growth between January and March of around 5.8%.
We quote, "The best news is that Prime Minister Narendra Modi’s government, which has loudly touted its stewardship of the Indian economy, appears to have woken up to the scale of the problem. Many would argue that the slew of administrative and tax changes that Finance Minister Nirmala Sitharaman announced as stimulus measures last Friday weren’t bold enough. But that misses the key point: Sitharaman and her ministry at last seem to be willing to take criticism on board and to adopt a more realistic view of India’s economic position. That’s the first step toward fixing the economy."How the government treads the space between its optimism and carefully structured policies will define whether the 5 trillion dollar economy dream remains unrealised or is fructified in the near future.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.